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Is It "Bad News Is Good News," or Something Else?

·3 min read

Market indices tried to fight back this afternoon, as they did successfully late Monday, but failed to reach mid-day levels and slid going into the closing bell. Session highs were right at the open, which were down from Monday’s close. The Dow lost -313 points, -1.01%, while the S&P 500 was -1.13% and the Nasdaq -0.95%. The small-cap Russell 2000 fared the worst for the session, -1.20%.

Fed Chair Jay Powell has already said, in his short, terse speech at Jackson Hole a couple weeks ago, that the Fed would go so far to turn around inflation as to allow for a U.S. recession. Technically, with two straight months of negative GDP, we’re already in one, but Powell was speaking toward something more serious, with more “pain”: sliding employment and wages, all in the cause of keeping inflation from eating up everything in sight. It’s completely "bad news"… until one considers the alternative.

Everyone by now knows the Fed is going to raise interest rates 75 basis points (bps) tomorrow, to bring the Fed funds rate to a range of 3.00-3.25%. This is up markedly from 0.00-0.25% in the first few days of March this year. After months of refraining from action — when it considered inflation a year ago “transitory” — the Fed has ratcheted up rates a quarter point in March, half-point in May, and two 75 bps hikes in June and July. After tomorrow, it will likely appear the Fed has gotten within the same ballpark with where the Fed funds rate ought to be, even if it was tardy getting here.

That’s not to say the Fed is finished hiking rates; somewhat above or below 4.00% will likely be where the Fed decides to stand pat until economic reads come through much lower over time. Such rapid ascension of interest rates over the course of a half a year cannot possibly have accounted for the entire rollover of inflation — and it certainly hasn’t, with year-over-year CPI still carrying an 8-handle, for instance — even as we’ve apparently achieved a “housing recession,” as mortgage rates were among the first places to get hit by the higher rates.

The 2-year bond yield is nearly — but remains just below — 4% today, which aligns conveniently with general projections for the Fed funds rate around the end of the year. (The 10-year, by the way, at 3.6%, is the highest it’s been since April of 2011. This, of course, means the yield curve on 2s and 10s remains inverted, and has been so since spring.) And, doing the math, with two more Fed meetings remaining after this one for 2022, it’s perhaps likely that neither see another 75 bps hike. So hack through the thickets of “bad news” and what do we find? A bit of “good news.”

All this talk about 4%+ bond yields will likely start to draw attention on its own, especially as long-reliable industries in equities like Tech continue to suffer in our current environment (we already recognize this as “bad news”). If investors start putting more assets into less-risky — and now profitable — Treasury bonds, this may pull the stock market down even further, near-term. And while this is bad news for investors, it would be music to the ears of the Fed. More “bad news is good news.”

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