Sep 19, 2022

When Good News is Bad News

When Good News is Bad News

The National Bureau of Economic Research called the economic expansion of the 2010s the longest on record. Its records go back to the 1850s. For much of the decade, good economic news was good news for investors.

Stocks performed well against the backdrop of modest economic growth, which fueled corporate profit growth. Low inflation and modest economic growth limited interest rate hikes by the Federal Reserve, further underpinning equities.

It’s a different environment today. Aided by fiscal stimulus, the economy recovered much faster than most had expected, including a return to full employment.

However, inflation is a big problem. While it would be unfair to blame today’s inflationary environment completely on the Fed—trillions of dollars in fiscal stimulus, pandemic lockdowns, and supply chain woes have also contributed to the problem, they are tasked with cleaning up the mess.

The rate of inflation may have already peaked, but whether the rate of inflation might plateau, decline slowly, or fall quickly is up for debate.

Yet, even if inflation has peaked, we aren’t yet seeing ‘peak hawkishness’ from Fed officials. Consequently, good economic news may encourage further hawkishness and rate hikes, which has created headwinds for stocks.

In other words, good economic news today could lead to bad news for investors, at least over a shorter-term time horizon.

The message from the Federal Reserve: failure to subdue inflation is not an option.

In an interview last Thursday at the Cato Institute’s Monetary Conference, Fed Chief Jerome Powell strongly reiterated the Fed’s commitment.

“History cautions strongly against prematurely loosening policy. I can assure you that my colleagues and I are strongly committed to this project, and we will keep at it until the job is done,” he said.

Bottom Line

There is a high degree of uncertainty regarding how high interest rates may rise, and how long rates may remain elevated to bring inflation down.

Would the Fed blink if the jobless rate drifts too high? The Fed’s not saying, but the unified message from Powell and various Fed officials suggests it will stay the course.

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