Fed Hiking Faster Than in 1994

The 1994 Fed hiking cycle is often mentioned as a very unusual period, but in 2022 the FOMC has increased interest rates faster and more than during the 1994 episode, and the FOMC expects this to be the biggest percentage point increase in the Fed funds rate in recent history, see chart below. Inflation is 8.3% and the FOMC’s inflation target is 2%. The Fed is trying to cool down the economy by tightening financial conditions, i.e. by pushing rates higher, credit spreads wider, and stocks lower. Investors should be positioned accordingly.

Fed is hiking rates faster than in 1994
Source: FRB, Haver Analytics, Apollo Chief Economist

The 60/40 Portfolio is Down 20% in 2022

If you had entered 2022 with a portfolio of 60% stocks and 40% fixed income, you would be down 20% so far, see chart below. With inflation still at more than 8% in the US, EU, and the UK, central banks will continue to push rates higher and stocks lower to cool down the economy and slow down earnings growth until inflation moves closer to the central banks’ 2% inflation target.

60/40 portfolio down 20% in 2022
Source: Bloomberg, Apollo Chief Economist. The Bloomberg US BMA6040 Index rebalances monthly to 60% equities and 40% fixed income.

Fed Withdrawing Liquidity

Monetary theory points to a sharp decline in inflation over the coming months, see chart below.

As the Fed withdraws liquidity, inflation will begin to come down
Source: BLS, FRB, Bloomberg, Apollo Chief Economist

US Macro: It is All About the Service Sector

The FedEx results don’t tell us much about the broader economy because goods only make up 18% of GDP, and consumer services such as air travel, hotels, restaurants, sporting events, and concerts are not slowing down. The bottom line is that the goods sector in the economy continues to cool down, and consumer services continue to overheat, see chart below. For markets, the implication is that the Fed will continue to slow down the interest-rate sensitive goods sector, including housing and autos, while we wait for the service sector to show signs of cooling down.

The goods sector is less than 20% of GDP
Source: BEA, Apollo Chief Economist. Note: Chart shows share of value added of  goods producing industries which cconsists of manufacturing, construction, agriculture, forestry, fishing, and hunting; and mining.

S&P500 Similarity with 2008

Last week, the S&P500 continued to follow the pattern seen in 2008, see chart below.

S&P500 is following a pattern similar to 2007-08
Source: Bloomberg, Apollo Chief Economist

A Rising Fed Funds Rate

At last week’s FOMC meeting, the Federal Reserve announced that they were raising interest rates by 75 basis points. They also reinforced the message that we can expect additional rate hikes until inflation starts to come closer in line with their 2% target. In a relatively short amount of time, the Fed has significantly changed their expectations on interest rates and the economic outlook. FOMC forecasts are now predicting that the Fed funds rate will hit 4.5% by the end of next year. Not so long ago, they had forecasted that the same rate would be zero at that point in time. Given this dramatic shift, it’s not surprising that assets like equities and credit continue to see spreads widening.

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Fed Expectations Changing

In March 2021, the FOMC thought the Fed funds rate would be zero at the end of 2023. Now they think the Fed funds rate at the end of next year will be 4.5%, see chart below.

Our attached Slowdown Watch PDF shows that the US economy is still overheating, with unemployment at 3.7% and inflation at 8.3%.

Chart showing rising projections for the Fed funds rate
Source: FRB, Apollo Chief Economist

Recession in Germany

The consensus is now expecting a recession in Germany in 2023, see chart below.

Chart projecting a recession for Germany in 2023
Source: Bloomberg, Apollo Chief Economist

Inventories Normalizing

Although services make up 80% of GDP, fluctuations in the goods sector are still important. Inventory levels are normalizing as a result of the supply chain improving and the goods sector of the economy slowing down, see chart below. Inventories for wholesalers are back to pre-pandemic levels, but inventories for retailers are still substantially below 2019 levels.

Chart showing wholesale inventories are back to pre-pandemic levels. But retail inventories are still below levels in 2019.
Source: Census Bureau, Haver, Apollo Chief Economist