The Bulls Are Fighting the Fed. That Might Be a Mistake

Have we finally reached a point where investors can buy stocks without fear? The answer doesn’t depend on how you define a recession, but on where you believe the economy is headed next.

The markets rallied on Wednesday in celebration of the Federal Open Market Committee’s latest three-quarter percentage point rate hike. Investors focused on Fed Chairman Powell’s assertion that the U.S. is not in a recession.

So how is the U.S. economy performing?

Copper has fallen 30% since reaching a multi-year high of $5 in March. Crude oil has lost 15% since June. These declines are indications of a slowdown, although both commodities have rallied in recent days.

The S&P 500 just had its worst first half since 1970. Inflation, as measured by the consumer price index, is at a 41-year high. The yield curve for U.S. Treasuries is inverted.

Some of the biggest names in tech, including Apple (AAPL) , Tesla (TSLA) , Microsoft (MSFT) , and Meta Platforms (META) , have slowed hiring. Meta blamed its poor performance on a decline in advertising revenue. My belief is that stock has more downside ahead.

Recent housing data has been soft. Just this week, sales of new homes and pending home sales came in below expectations. Sellers are reducing their asking prices, and inventories are rising.

It is in this environment that the FOMC raised the Fed funds rate by three-quarters a percentage point on Wednesday. Fed Chairman Powell made it clear that fighting inflation is his top priority.

Powell also declared that, due to strength in jobs and other areas, “I do not think the U.S. is currently in a recession.” That statement gives Powell more leeway to raise interest rates in the future.

According to the CME’s 30-Day Fed Funds futures contracts, the Fed Funds rate will peak at 3.25% to 3.5% early next year. That means we can expect an additional hike of the same amount or even higher, at 1%, by the end of this year.

Graphic courtesy of CME.

Meanwhile, we haven’t seen the full effect of the June and July rate hikes, a total of 1.5 percentage points.

It’s my belief that markets are underestimating Powell, and underestimating how high the Fed Funds rate will climb. They may also be underestimating the length of time that rates will remain high.

I’m not convinced that Powell and the FOMC will be finished by the end of the year. Inflation is Powell’s top priority, and he stated on Wednesday, “Another unusually large increase could be appropriate.”

Right now, the bulls are fighting the Fed. That may work out in the near-term, as markets currently seem determined to see every glass as half-full, but in the long run, it’s a dangerous strategy.

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