Rising Inflation Spooks the Stock Market and Signals Recession
If you have a balance on a credit card or an adjustable-rate mortgage,?you might be notice?changes in your payments. Higher interest rates are starting to ripple through the personal finance landscape, and it doesn’t?look like that trend will change anytime soon.
Managing inflation is the job of the Federal Reserve, and the Fed’s?approach to?monetary policy reflects its near single-minded focus on?higher prices in 2022. The Federal Reserve raised its benchmark interest rate by?0.75 percentage points on June 15, the biggest hike in almost 30 years.
The Federal Reserve has indicated it plans to keep raising short-term interest rates to help manage inflation, which is at its highest level in 40 years. The Fed hopes to slow spending by raising interest rates, bringing down consumer prices.
When inflation is running hot, you feel its overreach in almost every corner of the economy. People see it when they buy gas at the station?and milk at the grocery store, but its influence also touches mortgage rates, credit card debt, and overall consumer confidence.
In recent weeks, the “recession” has started creeping into business news and financial market coverage. Is that cause for alarm or just another attention-grabbing headline? There’s no easy, single answer.
A recession is defined as two consecutive quarters of negative economic growth as measured by gross domestic product (GDP). But GDP is a lag indicator, so technically, we would not know until sometime in 2023 if we lived through a?recession in 2022.
One leading indicator that has signaled a recession in the past appears to be appearing again: the yield curve. In an expanding economy, the yield curve slopes upward to the right. In a slowdown, the curve can invert and, the yield on short-term Treasuries is higher than longer-term ones.
If your interest rate for a money market account or 1- or 2-year Treasury or certificate of deposit (CD) is equal to or higher than the interest rate on a 5- or 10-year CD or Treasury, the curve is inverted. An inverted yield curve suggests that investors have lost some long-term confidence in the economy and have started shifting money to protect what they have today.
Some swear by the yield curve, pointing out that it’s become inverted before?every recession in recent memory. Others are not so certain. They explain?that while today’s “nominal curve” did invert, the “real curve”, adjusted for?inflation, tells a different story.
To add to the complication this time, we have some of the elements of “stagflation”: slowing or no economic growth combined with rising inflation. We last saw this in the 1970s, when there was a similar mix of war (Vietnam) and oil shortages (the embargo by the Organization of Petroleum Exporting Countries, or OPEC). Today sees continuing COVID supply chain disruptions and Russia’s invasion of Ukraine.
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No doubt that stocks have been gut-punched in the first half of 2022, with some stock sectors such as consumer discretionary and financials seeing their post-pandemic gains get wiped out in recent weeks. Bears and bulls are now locked in a cage match. Bears say the Fed’s rate-increase cycle will lead to a recession, dragging stocks even lower. Bulls are finding reasons for optimism, such as lower used-car prices and generally solid first-quarter corporate earnings. (The bear bandwagon seems to be growing daily with increasing evidence for its point of view.)
It’s not easy sorting through the economic noise these days. Our team examines various indicators, including the yield curve, corporate earnings forecast, mortgage and, car purchasing.
Overall, your strategy should consider?that there will be transition periods in the economy as we rotate from one business cycle to the next.
When it comes to charting the course for your portfolio, including potential changes, and time?in the markets, not timing the markets?remains the wise way to go.
Written by Walid L. Petiri
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