Professor Siegel's Weekly Commentary
I Caution the Fed Against Getting More Aggressive
June 27, 2022
We had a very strong market last week, with an over 8% bounce off the lows in the S&P 500. But I am not ready to say the market bottom is definitely behind us; this could be just a standard recovery after a major drawdown, and we had an even bigger bounce earlier in the year.
The market was encouraged by the final reading from the Michigan Consumer Sentiment survey on Friday, which showed a slowing of inflation expectations. This inflation indicator used to be ignored but given the importance of inflation and consumer inflation expectations, this survey has taken on more prominence. A few weeks ahead of this survey the breakeven inflation rates embedded in TIPS bonds showed inflation expectations decreasing, but Powell justified the 75 basis point increase with the consumer survey data.
It seems like everyone is turning into a Fed hawk. Yet, I am increasingly worried about the economic data coming in; practically every real economic data is showing a slowdown, with the exception of good housing data that came in on Friday. The global Purchasing Managers Indexes (PMI) have been very downbeat.
We’ll get the key monthly money supply data on Tuesday of this week and I think it will show another stagnation or even a potential decline as more frequent weekly indicators I watch have turned down. Readers know it was the money supply data that caused me to call inflationary risks to the upside and that trend now looks like it has reversed.
First quarter GDP came in at -1.5% and the reads I am seeing call for +0.9% for the 2nd quarter, translating to a declining economy in the first half of the year. What is remarkable is that earnings growth has been so resilient, despite this sluggish economic data.
We know Consumer Price Index data is going to come in looking bad for a number of months due to lagged data and calculations, but the live and real-time forward looking inflation numbers are coming down quickly. Commodity indexes are back to where they were in the days before the invasion of Ukraine, wiping out the increase from the war. Gas is back below $5 a gallon. Commodity inflation and housing inflation may well be over and trending downward, but the inflationary pressures that will be longer lasting are services that stem from labor supply issues.
The Fed cannot ignore the economic slowdown. While everyone now is racing to out-hawk each other, one prominent hedge fund manager wrote a 5% Fed Funds Rate is possible next year given the high inflation in the system. I am repeating my call that the Fed decision at the July meeting should be to hike between 25 and 50 basis points instead of the 75 basis points the market now assumes is pre-ordained.
I caution the Fed against getting more aggressive than what is currently priced into the Fed Funds Futures market. Ratifying and hiking rates in line with current expectations is appropriate, but I do not think the Fed should get overly aggressive with rate hikes now. The Fed Funds Rate is very close to being above neutral and into restrictive territory, and the July meeting very likely takes them there. Hopefully the Fed does not overreact to lagged inflation data.
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