The March minutes confirm Brainard’s comments from earlier in the week. Brainard is a more dovish Fed member and she dropped the news that the Fed could begin to reduce the balance sheet as soon as May. The conclusion from the minutes is that a 50bps rate hike is expected in May and the minutes had all members of the board wanting to announce the start of the balance sheet run-off at a ‘coming meeting’. This could mean QT is announced in May too. Now there were no even more hawkish surprises from the minutes, but it does show the Fed is tackling inflation head-on. The risk with this is that by aggressively tackling inflation they also slow growth.
The immovable force meets the unstoppable object
Some things are impossible. You can’t have a one-ended stick or a square circle. The Fed faces the near-impossible task of bringing down inflation without hindering growth. The reason this is so hard is that the only real tool a central bank has to control inflation is to hike interest rates. The problem with this is that as interest rates increase the economy is naturally slowed down. Borrowing becomes more expensive, household expenditures are reduced, and in the current climate with an energy price crunch, the risk of recession is high. According to the investment analysts ING, Fed put it as high as a 30% chance within the next 12-18 months that the US is heading into a recession.
The housing risk
One key area of risk they flag is the housing market. Applications are dropping for mortgage applications as rates for a 30y fixed mortgage rate soar.
The yield curve inversion
Another signal of a coming US recession has been from the US 10-02 year curve inversion. Every time this curve has inverted since the 1950’s the US has fallen into a recession with only one exception. You can see the inversion below.
The headwind for stocks
All of the above means that stocks could see another down leg as investors prepare for a potential recession. If the S&P500 falls more than 23+% that typically signals a recession risk. See here for the previous times those levels of falls have signalled a recession
That would mean 3600 or 3700 could be a good value area for medium-term buyers. If the US heads into a recession then eventually the Fed will change its policy and start cutting rates again. So, savvy investors will be planning the Fed’s potential exit from their hiking cycle now.