Is there light at the end of the tunnel? Sure, The Wall Street Journal reported that a 75 basis point hike at the upcoming Fed meeting is all but signed and delivered, but Federal Reserve Vice Chair Lael Brainard said that “at some point” there will be risks from overtightening, and the
Beige Book said the outlook for future economic growth remained “generally weak.
” Heck, even Apple
Add that up, plus maybe some technical factors, and the S&P 500
Harley Bassman, managing partner at Simplify Asset Management and the self-described Convexity Maven, does not count himself in the imminent pivot camp .
“The markets are pricing derivative contracts to win if the fed funds rate peaks near 3.75% in the spring of 2023, with the embedded implication that rate cuts will soon follow. I will take the other side of that trade,” says Bassman, who created the MOVE index measuring interest rate volatility during a storied career at Merrill Lynch.
He likens the Fed’s attempts to bring down inflation to attempting to slice a loaf of bread with a chainsaw. And while he agrees that many economic indicators are pointing to a potential slowdown for the economy, Bassman doesn’t expect inflation to weaken very much. The shelter component of CPI makes up nearly a third of the index, and it tends to lag market prices by six to nine months. Since rents as measured by Zillow and Apartment List are still moving higher, it follows that the shelter component has some ways to rise.
He also said it’s unlikely the recent pullback in energy prices will be sustained into the winter. While there’s a big gap right now between European and U.S. natural-gas prices, he expects over time these prices to converge. “I can assure you it will not be euro prices collapsing,” said Bassman.
This leaves the Fed, rather than an approaching recession, to do the dirty work of stamping out inflation. Adjusted for inflation, the fed funds rate right now is still quite stimulative, and even a 4% fed funds rate won’t reduce inflation pressure, he says. He’s not expecting the Fed to dial back until inflation is at a 3% handle and unemployment is well above 4%.
The Fed’s hikes already have landed a blow to the housing market. He calculates that a potential owner with $1,900 per month to spend on a house can afford a $385,000 home now, compared to $500,000 at the start of the year.
“Since it is unlikely house prices will decline by 23%, especially with the Millennial demographic forming families, the more likely outcome is that the extra cost of a mortgage will be drawn from the discretionary spending on their beloved ‘experiences’; and this will reduce overall economic demand,” he said. Another drag to the economy is coming from reduced migration.
The European Central Bank opted for a 75 basis point rate hike, its largest-ever increase.
Fed Chair Jerome Powell takes part in a moderated discussion, while jobless claims fell to a 3.5 month low of 222,000 .
U.K. Prime Minister Liz Truss announced a plan to cap household energy bills for two years.
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