By Gargi Pal Chaudhuri
This year, the Federal Reserve raised interest rates for the first time since 2018.
But what do these rate hikes mean for investors and the wider market? Let’s talk about it.
Factors such as labor shortages, rising wages and supply chain issues have pushed inflation to its highest level in 40 years. People have felt it in the price of everything from a dozen eggs to a gallon of gasoline. Raising interest rates is one of the ways the Federal Reserve uses to fight inflation.
Basically, these rate increases make borrowing more expensive, whether for a home, car or business loan.
Making loans more expensive may encourage individuals and businesses to be more selective in their spending and investments.
This can help lower prices and fight inflation, but it can also mean slower economic growth, which can contribute to market volatility.
While the Federal Reserve manages this balancing act, investors may consider their own rebalancing.
Investors might consider devoting a portion of their portfolios to quality companies, those with stable cash flows and higher profit margins that can absorb or pass on higher prices.
To prepare for a potential downturn in the economy, investors could also consider minimum volatility ETFs such as iShares MSCI USA Min Vol Factor ETF (USMV).
More importantly, remember that market dips and peaks are part of normal long-term cycles. And these small incremental steps may be one possible solution to help investors — and the market itself — get back to normal over the long term.
Key points to remember
- The US economy has slowed for two consecutive quarters, does that mean we are already in a recession?
- Our recession monitor flashes pink in two of its five categories. This is concerning, but not necessarily indicative of an impending recession.
- Recession risks increase as US economic data softens. Slowing periods of growth could favor fixed income, value stocks and minimum volatility strategies.
The economy shrank 0.9% in the second quarter from a year earlier, the second straight decline in quarterly U.S. GDP. So, are we in a recession?
We think the answer is “not yet”. Our own recession platform (see below) shows 2 out of 5 indicators flashing pink; but not all 5. Still, the risks of a recession have increased as US economic data darkens.
BlackRock Recession Monitor: signs of weakness, but no recession (yet)
In line with the advanced Q2 GDP report, our recession monitor flashes pink for business health, but shows strong consumption and still fairly easy credit conditions. Economic indicators such as real income, spending and the labor market certainly do not yet show the widespread decline historically associated with a recession.
That said, second-quarter GDP fell 0.9%, well below expectations for a modest rise, after falling 1.6% in the first quarter. The drivers of the second quarter decline were:1
- A slump in inventory investment as retailers sit on unsold goods. (Earlier this week, the world’s largest retailer said it was slashing prices for discretionary goods as inventories rise.)2
- A decline in residential investment given the decline in housing construction
- A drop in investment in the non-residential structure, showing that the office segments continue to struggle with expansion plans – particularly in a stalled growth environment.
The Federal Reserve acknowledged the slowdown on Wednesday — “real indicators of spending and output softened,” according to the FOMC policy statement — even as it issued another rate hike of 75 basis points.
What is a recession anyway?
Although “two consecutive negative quarters” is commonly used, ultimately there is no better definition of a recession. There are different ways to measure economic activity and the rules-based approach of “consecutive negative quarters” may lack nuance. The National Bureau of Economic Research (NBER) is the official arbiter of US recessions; the NBER uses a qualitative, more subjective approach.
We are currently in such an atypical cycle that we are more inclined to favor a qualitative approach to a call for recession, whether that of the NBER or our own recession monitor. This is especially relevant today because early GDP cuts are often revised, something Fed Chairman Jay Powell pointed out at a press conference after the Fed’s rate hike.
In this environment, we believe it is important to remain invested in the markets, but recognize that volatility may remain higher, as detailed in the 2022 Mid-Year iShares Investor Guide.
Ultimately, we believe the Federal Reserve – which raised the target federal funds rate from 0-0.25% in early 2022 to 2.25-2.5% now – will need to slow its pace of rising interest rates. rate if economic activity continues to stagnate. The market currently expects rates to rise to over 3% by the end of 2022 before falling in 2023 to support a slowing economy.3
Slower periods of growth may favor fixed income allocations; a weaker dollar, which will likely result from a slower pace of rate hikes, could favor emerging market bonds. Within equities, strategies that emphasize minimal volatility and companies with healthier balance sheets may fare better than the market as a whole.
© 2022 BlackRock, Inc. All rights reserved.
1 Source: BlackRock, US Bureau of Economics Analysis, report on the advanced estimate of GDP in the 2nd quarterJuly 28, 2022.
2 Source: Walmart Inc. Provides Second Quarter and Fiscal 2023 UpdateJuly 25, 2022.
3 Source: CME Group’s FedWatch Tool, as of July 28, 2022.
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