Wash, rinse, and repeat in financial markets

January 06, 2023

keeping an eye on financial market changes

Here we go again. Central banks around the world, especially the U.S. Federal Reserve (Fed), declare inflation rates are too high and commit to bringing them down via interest rates hikes. Markets react negatively as the cost of capital rises. Time passes and investors become convinced hikes are about to end and the Fed will soon pivot to rate cuts. Then markets rally in anticipation of easier financial conditions. The Fed hikes rates again and restates its commitment to going further. Markets sell off for the same reason they did before, then the whole process starts over. Wash, rinse, repeat.

Financial markets posted impressive gains through most of the fourth quarter because the “Fed pivot” thesis returned as a dominant theme. Interest rates set by financial markets actually fell during the period despite no indication that monetary policy set by the central bank would change course. This week, the Fed hiked interest rates by 50 basis points and affirmed its belief that more will be required to get inflation under control. Down go markets.

Investor sentiment is whipsawing in unhealthy ways. Rather than participate, let’s focus on a few things we know for sure:

  1. Pipeline inflation is coming down, but consumer inflation is still very high
  2. The Fed knows inflation is worse than recession and is willing to induce the latter to kill the former
  3. The economy is slowing quickly, bringing an end to the current rate-hiking cycle closer everyday
  4. Even so, more rate hikes are likely on their way
  5. Jumping back into markets just before the Fed pivots to rate cuts is a fool’s errand. Best to not jump out to begin with.
  6. A recession is likely next year. That could set the stage for more volatility followed by a rally as expectations shift to economic recovery with low inflation.

Scott Knapp-4
Written by: Scott Knapp, CFA

Scott D. Knapp is the Chief Market Strategist with Cuna Mutual Group. Scott is responsible for investment philosophy development and program implementation for Cuna Mutual Group’s Institutional Retirement Programs. He regularly speaks at economic and investment forums across the country. Connect with Scott on LinkedIn.

The views presented here are the author’s alone and not necessarily representative of opinions held by CUNA Brokerage Services, Inc. or any affiliated entity.