The Federal Reserve delivered a widely expected 50-basis-point rate hike this week, but surprised the markets by signaling rates would stay high through next year. At the meeting, the Fed revised their median prediction for core inflation in 2023 upwards by 40-basis-points from last meeting, putting 5.1% as the new interest rate destination before considering any pause to rate hikes. This was despite the November CPI (Consumer Price Index) coming in at 7.1% earlier in the week, down from 7.7% in October, signaling that inflation is coming down, albeit not as sharply as the Fed would like. In the call, Fed Chair Powell confessed that they have not made much progress on inflation and fully expects to stay the course to get inflation down to 2%. He, however, attempted to assuage recession fears by pointing to the median Fed GDP projection in 2023, which shows a half percent of growth.

The markets didn’t believe him and began a massive sell off on Thursday that continued through Friday as options and futures expiry drove further declines. The stock market is now coming to terms that a recession is inevitable and the Fed is simply wrong.

Future Wealth’s View

In our report just two weeks ago, we had questioned Fed’s approach to defying the Phillips Curve and stated that “2023 will see a significant decline in corporate earnings that will force a series of layoffs that will eventually raise unemployment levels which will in turn, bring inflation down to levels that pleases the Fed. But, the stock market won’t take rising unemployment and the decline in corporate earnings so kindly.” (The link to the article is here   https://futurewealthllc.com/attempting-to-defy-the-phillips-curve/).

We had also cautioned that inflation could be sticky i.e. remain high. With the labor market remaining strong, there is little reason to believe that inflation will come down rapidly. The markets are now coming to grips with the fact that unemployment will have to climb to about 6% from current level of 3.7%, to bring inflation down appreciably. At that rate of unemployment, the country will be in recession.

2022 has been a disaster for investors. It began with the Fed misreading the inflation that was caused by the $5 trillion injected into the economy by Congress and is going to end with the Fed misstating that a recession can be avoided in 2023.

Here is the bottom line for investors – The Fed knows that there will be a recession in 2023 but can’t say that publicly. The stock market, on the other hand, wants to believe that we can avoid a recession but the Fed keeps reminding it subtly every month, that a recession is inevitable.

Our advice is the same as we stated in our report few weeks ago – “In 2023, the stock market is going to be a tough place to be and investors will do well to take shelter in ultra safe investments – brokered CDs, municipal bonds and inflation protected securities – all of which will likely provide better returns until the stock market recovers in mid 2023 or later.”

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