Fed Actions and the Nervous Reactions

After three quarters of improving economic outlook amid increasing expectations for a painless decline in global inflation, markets and pundits alike have become less optimistic about a soft landing as they reacted to frustration from the Fed. In an unfavorable scenario for stock and bond investors in a quarter with little fundamental change, economic worries increased while interest rates rose sharply as the expectation materialized that interest rates would have to stay higher for longer to further slow the economy in the battle against inflation.

Investment Themes

Fixed income markets changed dramatically with one of the fastest moves in history for long bonds. The quarterly rise in 20- and 30-year rates is the highest since the beginning of the FRED data series in 1990.

This rapid rise in long rates effectively raises the cost of capital for firms seeking long-term financing. This along with the existing high short-term rates lessens pressure on the Fed to raise interest rates given that the work of pulling up the yield curve is already done (to some extent).

quarterly change

Stocks or Bonds?

After difficult periods for investors, many question the relative desirability of stocks and bonds—even more so with risk-free rates at high levels.

Stocks are again being priced for possible recession. If the market has correctly assessed the risk of recession, the price today already accounts for the risks of the future. This narrative implies an uptick in expected return and volatility for stocks going forward. Therefore, from an asset allocation perspective they remain a desirable asset class.