Growing Optimism After A Year To Forget

Look beyond the headlines to discover the driving forces behind market trends and consider how they impact a credit union’s investment portfolio.

Top-Level Takeaways

  • Although 2022 has been a year to forget, financial markets have been more optimistic about the prospect that peak inflation has been reached.
  • The Fed is likely to slow down the pace of rate hikes at its Dec. 14 meeting, but Fed Chair Jerome Powell expressed concern that an overheated labor market continues to fuel inflation in the services sector.
  • Fixed income markets appear poised to rebound in 2023 from the deeply negative returns of 2022.

It has been a year to forget for financial markets, but there is growing optimism the worst is over. If the Federal Reserve moves forward with what is widely expected to be a 50-basis-point rate hike at its Dec. 14 FOMC meeting, it would mark 425 basis points of rate hikes in just nine months. At the same time, the Fed has shrunk its bond portfolio since the beginning of June.

Recent economic data, as a whole, has shown signs of slowing economic growth, but there are two important questions for investors that remain unanswered: How high will the Fed ultimately take the fed funds rate, and how long will it stay at its terminal level?

After a strong Treasury rally on Nov. 30 — following a speech by Jerome Powell, chair of the Federal Reserve — the bond market was priced for a 4.93% terminal rate following the May 2023 FOMC meeting and a 4.45% fed funds rate by the end of 2023. In other words, markets are pricing for 50 basis points of additional hikes in the first half of next year, followed by 50 basis points of rate cuts in the second half of the year. Market participants are simply not buying the idea of “higher for longer” at this point, whether prudent or not.

Fed leaders have broadly acknowledged a slowdown in the pace of hikes will likely be appropriate beginning at the next meeting, but the notion of rate cuts in 2023 has not been mentioned as a consideration. Quite the opposite, in fact.

Nevertheless, financial markets remain ready to pounce on any hints of a Fed pivot, even if such an idea has been universally rejected by Fed leaders in recent weeks/months. They are fully aware any such dovish signals, even if subtle, would almost certainly spark a rally in bond yields and spreads that would work against the tightening of financial conditions they feel is necessary to combat inflation risks.

This market commentary is provided by ALM First Financial Advisors, LLC, the investment advisor for Trust for Credit Unions. Visit trustcu.com to read about the latest economic data and overall market trends.

Jason Haley, Chief Investment Officer, ALM First

Jason Haley is ALM First’s chief investment officer, joining the firm in 2008. He heads ALM First’s Investment Management Group (IMG) and is portfolio manager for the Trust for Credit Unions mutual funds. Haley and his team are responsible for leading the investment process and investment theme development for the firm. Haley also oversees all capital markets activities, including portfolio management, trading, market research and commentary, and execution of hedging and funding strategies for the firm’s depository clients. He holds an MBA with a concentration in finance and a BBA with a concentration in marketing, both from The University of Mississippi.

December 19, 2022

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