US headlines over the last quarter continued to swing negative.  Some days, even weeks, were tough to stomach.  Let’s take a step back, set the headlines aside, and explore the forces that we believe will have broader consequences over time. 

The Beese Fulmer team’s investment process naturally forces investment professionals to decipher between the daily headlines and the long-term drivers of the market.  Each member is continuously performing deep fundamental analysis, monitoring company management presentations, and communicating with wall street sell-side analysts to determine the true headwinds and tailwinds certain industries are facing.  Next, and a vital part of the process, is the collaboration among team members, bringing out common themes that must be monitored concerning investment decisions made in client portfolios.  These themes are evolving, forcing the investment team to adhere to its process.  Year to date, a recurring topic discussed is the communication (or overcommunication?) of the United States' central bank policies.

Communication is everything 

An adage on Wall Street is, “Don’t fight the Fed,” implying that investors should pay close attention to Fed policy and its broader implications.  Oftentimes, the communication of future policy changes can be more impactful than the tools utilized themselves.  Before the global financial crisis of 2008, the FOMC provided nominal guidance on its future use of monetary tools, but the instability of the financial markets in 2008 required the FOMC to place its playbook on display and provide long-term guidance on how its monetary tools would stabilize markets, but also set a precedent for investors to seek high levels of visibility into future decisions.

It could be argued that this approach was only necessary during extreme market circumstances and continuing to provide guidance ties the FOMC's hands to what was communicated in the prior meeting, versus adapting to new macroeconomic indicators in a timely manner.  For today, let's set the debate aside and review recent FOMC communications that have had a significant influence on the markets year-to-date and what could be expected in the next couple of months as a volatile 2022 comes to an end.

FOMC May Meeting: The attempt to be a hawk, but everyone heard a mourning dove call

One would believe the first 0.5 percentage point interest-rate rise in more than 20 years would come off as hawkish (maintaining inflation around 2%, even if it comes at the expense of economic growth), however, the market felt that Jerome Powell’s press conference on May 4th was a far cry from slowing economic growth.  His announcement of 0.5 percentage points for May, and then an additional 0.5 percentage points at its next two meetings were not going to slow down an economy that was registering year-over-year inflation above 8%, especially with leading indicators showing persistent near-term inflation.

Arguments prior to the May meeting revolved around whether the federal funds rate should be increased by 0.50 percentage points or up to a full percentage point.  What wasn’t expected was the commitment to raise rates by only 0.50 percentage points in June and July.  When asked about the possibility of a rate hike higher than 0.50 percentage points at the press conference, Jerome Powell effectively ruled out such a big adjustment and instead signaled half-point rate rises at the next two meetings.

Because the market has become accustomed to the Fed’s outlook, and it has been painful to “Fight the Fed,” this communication from Jerome Powell was translated into the FOMC seeing inflation under control with modest rate hikes and the potential for minimal damage to the growth of the US economy.  We later found out this is not the case and the Fed had to pivot from its May comments.

Jackson Hole: The hawk is unleashed

Fast forward to August 26th, two meetings since the first 0.50 percentage point hike.  Since then, the committee pivoted from its two additional half-point hikes to a 0.75 percentage point hike at the June and July meetings, as monthly inflation accelerated to new highs.  Subsequently, Jay Powell used a speech at Jackson Hole to deliver his most hawkish message to date on the US central bank’s determination to tame surging inflation by raising interest rates.  He declared the Federal Reserve “must keep at it until the job is done.”  In addition, Powell predicted there would “very likely be some softening of labor market conditions” and “some pain” for households and businesses.  US major indices tumbled more than 3% after this speech and have since pulled back to the year-to-date lows set in June.

The FOMC’s willingness to open its playbook, followed by sudden pivots in policy, could be doing more harm than good in today’s economy.  It was certainly needed during the global financial crisis, but today, the environment is different and the FOMC is flipping the script as new data comes in.  Resulting in elevated levels of market volatility and less confidence in the FOMCs ability to manage inflation without damaging the economy in doing so.

Another pivot in the cards?

Simply put, not likely in the near term.  On September 21, Powell signaled an intention to keep monetary policy tight as it fights inflation.  The FOMC released its dot plot interest rate projections that reinforced the central bank’s commitment to a higher-for-longer approach.  The forecast showed the benchmark rate rising to 4.4 percent by the end of this year before peaking at 4.6 percent next year, a staggering 1.0 percentage point move from the June dot plot projections.  The market immediately digested this new projection that the economy will have to go into a recession before the FMOC can bring inflation down toward its 2% target.

At Beese Fulmer, we stick to staying rational through these turbulent markets.  Our focus has been and always will be identifying great companies that are well-managed and can produce free cash flow throughout an economic cycle.  Reducing the need to sell at market lows and avoiding wealth destruction.  We are carefully monitoring price inflation at the granular level and while premature, find current trends positive for future inflation data.  Food, housing, and transportation account for 88% of the recent consumer price index spike indicating inflation is highly concentrated.  West Texas oil is trading down 35% from its year-to-date high, construction activity has fallen by 25%, home prices have dropped by 5% from highs, and grain futures have just started to fall.  If these trends were to continue, we could see the Fed’s forecasted dot plot become a ceiling for rates versus a target, another pivot and bullish for equity markets.  Time will tell.