Well, as he’s done all year, Fed chairman Jerome Powell, stopped the market dead in its tracks and reversed it lower. This week actually produced very good inflation news. On Tuesday we got the inflation CPI report that showed inflation dropped dramatically. From October to November inflation fell from 7.7% to 7.1% and this is after inflation dropped from 8.2% to 7.7% from September to October. What all this means is inflation is dropping dramatically. Two months in a row we’ve seen meaningful drops in inflation; exactly what the Fed wants.
However, the inflation the Fed is most worried about, wage inflation, hasn’t stalled or come down at all. Generally, wage inflation is a good thing because it means workers are getting paid more. The reason wage inflation is such a problem right now is because the job market is EXTREMELY tight. Meaning companies have to, essentially, bid for workers. This bidding war for workers is causing pay to skyrocket, so in order for companies to absorb this huge new cost they have to raise prices. As long as this bidding war goes on inflation can only drop by so much. The Fed needs wage inflation to cease to hit its target of inflation returning to 2%. And the only way that happens is for the unemployment rate to rise, meaning the Fed wants to see people get laid off. Right now the unemployment rate is at a historic low of around 3.5%. The Fed what’s that rate up to around 4.5% to 5%.
Powell was extremely hawkish in his news conference yesterday after the Fed raised rates by 0.50%. Saying that regardless of the progress they are seeing with inflation coming down, more work has to be done and they see more rate hikes in the new year. The market was not anticipating such hawkish language. The market was hoping to hear him say they are close to the end of hiking rates due to the drop in inflation.
Powell’s hawkish tone now has the market anticipating the R-word happening next year… Recession! The economy is slowing, as is evident by inflation coming down but the fear is that it’s slowing too much and we’ll fall into a recession. In recessions, the market typically drops by about 25 to 30%. At its lowest point this year the market was down 25% so if we do fall into a recession we can expect the market to retest the lows the market made last month and maybe drop a bit further from there.
While this generally isn’t good news, the good part is the market has dropped a lot already this year so we are closer to the bottom than the top. Now, how this all plays out, I have no idea. I’m just laying out the current state of the economy and the market. We’ll see how it all goes. But as I’ve been saying since October, we are closer to the bottom than the top, so now is the time to put money to work in the market. The first half of next year is most likely going to be similar to this year. But the Fed will be done raising rates by mid-2023 so the 2nd half of 2023 is setting up to be when the recovery takes place.
But I want to make this point crystal clear, this extremely hawkish Fed is not playing games when it comes to inflation. They are willing and VERY capable of pushing us into recession in order to kill inflation. Killing inflation is their mandate, period, full stop!