Hawkish Fed argues for keeping defense on the field Hawkish Fed argues for keeping defense on the field http://www.federatedinvestors.com/texPool/static/images/texpool/texpool-logo-amp.png http://www.federatedinvestors.com/texPool/daf\images\insights\article\goalie-defender-small.jpg July 22 2022 July 21 2022

Hawkish Fed argues for keeping defense on the field

Rising recession risk favors defensive dividend stocks, cash and Treasuries.

Published July 21 2022

We have become even more defensive on risk assets since Federal Reserve policymakers met in June and we see little reason to change that stance before they meet again next week. Another 75 basis-point hike is the consensus as stubborn inflation keeps struggling to clear the “peak” hurdle. Last week’s report on June CPI—headline 1.3% month-over-month and 9.1% year-over-year increases—blew through forecasts, with the monthly increase a cycle high and the fifth-largest ever recorded in the U.S. Futures immediately priced in a 1 percentage point increase in the target funds range for the two-day July 26-27 meeting, before settling back in the intervening days to a still rare three-quarter-point hike. Some of this may reflect fallbacks in key commodity prices this month, with oil prices flirting with $100/barrel, gas prices back under $5/gallon and agricultural commodity prices off the boil.

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Still, whether a 75 or 100 basis-point hike next week, the Fed over the past four months will have raised policy rates at the fastest pace since the Volcker years. Then again, prices have never risen as fast since then. Even with some easing in commodity inputs, readings in services industries and the second-order effects from spring’s spike in energy and commodity prices should keep inflation elevated for some time, meaning the Fed’s far from done. Including next week’s meeting, futures are expecting 200 basis points of additional hikes this year, putting the target range at 3.50-3.75%. After next week, it will be interesting to see if policymakers make an interim move given their next regularly scheduled meeting isn’t until late September. At the least, they likely will lay out their thinking for the rest of the year at the Kansas City Fed’s annual Jackson Hole, Wyo., confab in late August.

Our takeaway is this: with the Fed sticking to its hawkish guns amid an economy that’s already slowing—housing and manufacturing data are softening, jobless claims are rising and consumer sentiment is near all-time lows—a “rocky landing”/recession scenario is building. Overseas, the story is even worse in developed markets. This argues for defensive dividend-paying value stocks and cash, and against growth stocks, credit-oriented bonds (investment-grade and high-yield corporates and emerging markets) and European exposure. One area that could benefit: longer-term Treasuries, where yields may have peaked on increasing recession odds. Our secondary “hard landing/stagflation” scenario is worse. It envisions a prolonged, potentially deep downturn with inflation staying high. This would argue for avoiding all risk assets and loading up on cash and short-duration products. Way too early to make that call. But it’s worth keeping in mind as we move into what historically has been a challenging period.

Tags Monetary Policy . Active Management . Inflation . Interest Rates . Markets/Economy .
DISCLOSURES

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.

Consumer Price Index (CPI): A measure of inflation at the retail level.

Diversification and asset allocation do not assure a profit nor protect against loss.

Growth stocks are typically more volatile than value stocks.

High-yield, lower-rated securities generally entail greater market, credit/default and liquidity risks and may be more volatile than investment-grade securities.

International investing involves special risks including currency risk, increased volatility, political risks, and differences in auditing and other financial standards. Prices of emerging-market and frontier-market securities can be significantly more volatile than the prices of securities in developed countries, and currency risk and political risks are accentuated in emerging markets.

There are no guarantees that dividend-paying stocks will continue to pay dividends.

Value stocks may lag growth stocks in performance, particularly in late stages of a market advance.

Federated Global Investment Management Corp.

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