The Fed’s interest rate hiking policies last year resulted in the end of the longest stock and bond bull markets in recent history. And the Fed is clearly not done yet. So, should we expect more carnage in 2023? Most forecasters say yes. They may be correct.
However, the Fed’s plans are clearly known, and many analysts agree the markets are already priced for the Fed’s upcoming rate hikes. I tend to agree, unless the Fed has to raise rates even more than expected to get inflation under control, which can’t be ruled out.
That’s what we’ll talk about today. Following that discussion, I’ll get into President Biden’s plans to add 87,000 new IRS auditors, the funding for which was included in his latest bloated $1.7 trillion budget bill.
Republicans now in control of the House should immediately move to squash this outrageous expansion of the IRS, as they have promised. It remains to be seen if they will. Let’s get started.
Fed Monetary Policy Looks to Be the Key Again in 2023
As we kick off the New Year, most investors are looking at their portfolios, wondering if we’ll see another down year in 2023 and trying to decide if they should make any adjustments.
I don’t like to simple things down too much, but in this case: the Fed hiked rates significantly in 2022, and the financial markets had a conniption. The S&P 500 Index fell over 18% and the Nasdaq 100 plunged over 32%. Bonds cratered. It was the worst year since 2008.
The question is: what will the Fed do in 2023? Most forecasters believe the Fed will continue to raise its short-term borrowing rate several more times in the first half of 2023, then pause for a while, and start lowering rates again in the last half of the year.
But this is pure speculation. No one knows with any certainty what the Fed will do. I don’t think the Fed itself knows what it’s going to do. It all depends on what happens with inflation which soared to 40-year highs in 2022 when the Consumer Price Index spiked to 9.1%.
The CPI has since come down a bit, currently at 7.1% as of November, but is still a far cry from the Fed’s target of 2% where it was back in 2020. I personally do not believe the Fed will be successful in getting the CPI back to 2% unless the economy goes into a serious recession.
How High Will Short-Term Interest Rates Go In 2023?
As pointed out above, no one knows how high short-term interest rates will go this year. The current target range for the Fed Funds rate is 4.25%-4.50%. That is up from 0.25%-0.50% in March of last year when the Fed started methodically raising its key lending rate.
Fed Chairman Jerome Powell has said he expects the Fed Funds rate target to rise to 5.0%-5.5%, but he has also emphasized that this is just an estimate and admits no one knows how high the rate will have to go to get inflation under control.
Powell has suggested the Fed Funds rate may have to remain at 5% or above for an extended period to get inflation under control. Other members of the Fed Open Market Committee (FOMC), the Fed’s policy setting committee, have warned the Fed Funds rate may have to go considerably higher to get the job done.
The point is, everyone who speaks for the Fed is sending the same message: the Fed is committed to getting inflation down no matter how long it takes. Everyone is emphasizing that the Fed will not lose its resolve and start to lower rates too early, as has happened in the past. The Fed seems as committed to getting inflation under control as I have seen it since the Paul Volcker days in the early 1980s.
Here is the schedule of the Fed Open Market Committee meetings this year:
Market Implications if the Fed Continues to Hike Rates
At this point, with it clear the Fed will continue to hike short-term interest rates, most forecasters are predicting a continued downward trend in the stock and bond markets. This may be the correct outlook to have.
However, with the Fed’s intentions so widely known, it seems clear the financial markets have already priced much of this in. If this analysis is correct, most of the damage may already be done and perhaps we should be looking for signs of a bottom before the middle of this year.
That depends, of course, on a couple of things: one, will the Fed have to raise rates even higher than 5%-5.5% to get inflation significantly lower; and two, how long the Fed will have to maintain rates at that even higher level?
Say, for example, the FOMC has to take the Fed Funds rate to 7%, as one Fed governor predicted last month, and it has to hold it there for several months or more. This would virtually guarantee a more serious recession this year.
The financial markets are not currently priced for this more bearish scenario, and if it happens, I would expect more carnage in the financial markets this year. Understand, I’m not predicting this, but we can’t rule it out either.
Finally, I understand that most people reading this letter, certainly my clients, are not looking to “time” the stock and bond markets. Most people reading this, and certainly my clients, invest in strategies they believe in and follow.
However, we do have a contingent of readers who are either active traders and/or believe in timing the market. I offer these market analyses for those readers. I hope it is helpful.
Gary D. Halbert is the president and chairman of Halbert Wealth Management, Inc. His Forecasts & Trends Weekly E-Letter may be obtained free of charge by subscribing at www.halbertwealth.com.