SUMMARY
Given where US monetary policy is heading, chasing sharp rebounds in risky equities and high yield credit on short-covering moves is not an ideal strategy for the year ahead.
- If you wanted Federal Reserve Chairman Jerome Powell to provide guidance that the US economy would remain strong in 2023 and that the central bank would be careful to pause and protect it, his Jackson Hole speech was disappointing.
- Powell held out hope for the period beyond what will be a near-term difficult phase for the economy. He noted that long-term inflation expectations have remained low even as the Fed has tightened. This means the conditions prior to the early 1980s – a 15-year period of accelerating inflation followed by two deep recessions – are unlikely to be repeated.
- How much tightening will it take for inflation to sufficiently tamed? Powell said reducing inflation is likely to require a sustained period of below-trend growth. In our view, this is set to occur in 2023 on the Fed’s rate hikes of 2022 and concurrent action to reduce lending to the bond market.
- As we discussed in our last forecast, we expect a stall or retrenchment in the economy in the period ahead, but not a long-term slump.
- Slowing growth and tightening monetary policy should end the Fed’s rate hikes by early 2023. Ending QT will likely come closer to the point that the Fed eases again. This may also come before 2023 has ended.
- Our advice to investors is clear. Quality matters. Dividends matter. Earnings will matter. Easy monetary policy will not be forthcoming to bolster weak assets. Chasing sharp rebounds in risky equities and high yield credit on short-covering moves is not an ideal strategy for the year ahead.
- We continue to overweight portfolios seeking the reliable sources of return: investment grade credit and strong dividend paying shares. Most US bonds did not lose value on his message that the Fed would see the present inflation fight through. Bonds are, indeed, back.
