Fed Rate Hike, Recession Expectations Shift Investor Focus To Q1 2023

Summary

• The final week of July 2022 came with two major news events shaping S&P 500 investor expectations for the future.
• The Fed hiking rates into an already weakened economy increases the likelihood the Fed's efforts to fight inflation by hiking short-term interest rates will more fully put the U.S. economy into recession.
• After the Fed boosted the Federal Funds Rate by 0.75% to its new target range between 2.25% and 2.50%, the CME Group's FedWatch Tool projects a half-point rate hike in September (2022-Q3).

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The final week of July 2022 came with two major news events shaping S&P 500 (SPX) investor expectations for the future. Wednesday, 27 July 2022, saw the U.S. Federal Reserve follow through with its second 0.75% rate hike of the year, while Thursday, 28 July 2022, saw the U.S. Bureau of Economic Analysis report that real economic growth in the U.S. was negative for the second quarter.

The Fed hiking rates into an already weakened economy increases the likelihood the Fed's efforts to fight inflation by hiking short-term interest rates will more fully put the U.S. economy into recession. That outcome means the Fed's plan to continue hiking rates until inflation is under control is likely to come to a screeching halt sooner than previously expected. More importantly, it pushes up the timetable for when the Federal Reserve will have to swing into reverse and begin cutting rates instead. The odds that will happen as soon as the first quarter of 2023 rose substantially as investors assessed the impact of these major market-moving news events.

In terms of the latest update to the dividend futures-based model's alternative futures chart, these changes prompted investors to shift their attention from the current quarter of 2022-Q3 outward to the more distant future of 2023-Q1, sending stock prices upward in the process. That change represents the ninth Lévy flight event for the S&P 500 index in 2022.

Meanwhile, it was a jam-packed news week for market-moving headlines, of which the Fed's rate hike and the second consecutive negative real GDP report were the biggest events:

Monday, 25 July 2022

• Signs and portents for the U.S. economy:
  • U.S. economy slowing, but recession not inevitable, Yellen says
  • U.S. interest rates peak seen by January 2023 - fed funds futures
  • Oil rises $2 as dollar eases, market wary of Fed
• Bigger trouble developing in Japan, Eurozone:
  • Japan slashes fiscal year GDP growth f'cast to 2.0% on global demand slump
    • BOJ new board member says exit from easy policy will become focus if wages rise
  • Germany on cusp of recession, says Ifo, as business sentiment sinks
• Bigger stimulus developing in China:
  • China to step up support for cultural and tourism recovery - central bank
  • China plans real estate fund worth up to $44 billion for distressed sector -source
    • Evergrande's debt revamp to provide roadmap on tackling China property crisis
• ECB minions claim they're watching Eurozone economy as they embark on rate hikes:
  • European Central Bank will consider economic situation when deciding on rates -Holzmann
  • ECB's Kazaks says big hikes may not be over after July move - Bloomberg
• S&P 500 ends choppy session nearly flat; investors eye Fed, earnings

Tuesday, 26 July 2022

• Signs and portents for the U.S. economy:
  • Oil settles down on lower U.S. consumer confidence, coming SPR release
    • U.S. to sell additional 20 million barrels of oil from strategic reserve
  • U.S. consumer confidence near 1-1/2-year low; house prices still high
  • U.S. new home sales drop to two-year low in June
• Fed minions to keep communicating its plans for rate hikes, including to Chinese spies:
  • Fed chair Powell is not done telling markets where rates will go
  • Fed not adequately prepared to thwart Chinese information gathering -report
• Bigger inflation, trouble developing in S. Korea:
  • S.Korea's economy unexpectedly speeds up, pointing to more rate hikes
  • South Korea plans financial tool to head off crises
• Bigger stimulus developing in China:
  • China money rate falls to 1-1/2 year low ahead of month-end demand
• BOJ minions not about to give up never-ending stimulus:
  • BOJ to keep rates low, any change to policy will be gradual - ex-board member
  • BOJ agreed on need for low rates, saw wage hikes as key to outlook
• ECB minions starting to notice inflation in the Eurozone:
  • ECB's De Cos says risks to inflation outlook in eurozone have intensified
• Indexes drop as Walmart profit warning spooks investors
  • Stocks fall, bonds rise as investors seek safety

Wednesday, 27 July 2022

• Signs and portents for the U.S. economy:
  • Oil settles higher on U.S. inventory drop, Russia gas cuts
  • U.S. pending home sales tumble in June as mortgage rate soar
  • U.S. exports, business spending may salvage second-quarter GDP
  • Moderate rebound in U.S. economic growth seen in second quarter as inflation bites
• Fed minions "jack" rates, hints at pause in rate hikes as economy worsens, but won't surrender inflation fight:
  • Fed jacks rates again, Powell vows no surrender in inflation battle
• Instant View: Fed hikes rates another 75 basis points
• Dollar falls after Fed hike, Powell comments
• Fed's Powell's absence of specific guidance leaves analysts to fill the gaps
• Bigger trouble developing in the Eurozone:
  • Russia cuts gas flows further as Europe makes savings plea
  • JP Morgan forecasts eurozone recession as gas crisis looms
  • Europe's banks flash some good news but downbeat on economy
• ECB minions hoping to avoid thinking about Italy will have to:
  • Analysis: ECB faces Italian debt test as politics intervenes
• Nasdaq has biggest one-day jump since 2020 after Fed rate hike, Powell comments
  • Microsoft, Alphabet results spark rally in mega-cap stocks

Thursday, 28 July 2022

• Signs and portents for the U.S. economy:
  • GDP fell 0.9% in the second quarter, the second straight decline and a strong recession signal
    • U.S. yield curve flashing more warning signs of recession risks ahead
    • 'Doesn't sound like a recession': Biden optimistic despite economy contracting
    • Mastercard warns of inflation pinch after solid quarter for card issuers
• Fed minions worrying about rising cost of food:
  • Powell's focus on 'pain' of inflation in one data point: More Americans are hungry
• Bigger trouble developing in Australia, Eurozone:
  • Australia cuts growth outlook as inflation bites
  • German inflation rises unexpectedly after fall in Russian gas supply
    • From grain to gasoline: a brief world history of rationing
• Bigger trouble, stimulus developing in China:
  • China omits mention of GDP growth goal, aims for 'best possible' results instead
  • China targets $148 billion in financing for cash-strapped developers - FT
• BOJ minions starting to think about ending never-ending stimulus:
  • BOJ must always brainstorm ideas on ending low rates, says deputy gov
  • BOJ could target more flexible policy after Kuroda's departure -ex-board member Kiuchi
• ECB minions planning for panic:
  • If ECB sees market 'panic,' will activate debt shield, Visco says
• Wall St ends up sharply for 2nd day; Amazon.com, Apple jump after hours
  • Shares rally, U.S. Treasury yields fall as U.S. economy shrinks

Friday, 29 July 2022

• Signs and portents for the U.S. economy:
  • Analysis-Wall Street weighs job cuts as deals slide in battered markets
  • Tight U.S. labor market keeps upward pressure on wages; inflation heats up
  • U.S. consumer spending beats expectations in June; inflation accelerates
• Fed minions convinced they can control inflation, want to increase uncertainty:
  • Bostic: Convinced Fed needs to keep raising rates to control inflation
    • Ackman says rates should be 'materially higher' to kill inflation
  • 'Embrace the uncertainty' from less central bank guidance - former Fed officials
  • Fed's aggressive rate-hike path bolstered by new inflation, wage data
• Positive growth signs in Eurozone:
  • Eurozone Q2 growth accelerates, defies expectations of slowdown
    • Spain's second-quarter GDP growth of 1.1% tops estimates
    • France's preliminary Q2 GDP rose 0.5%, beating forecasts
    • Italy's economy grew faster than expected in Q2, back above pre-COVID levels
• Bigger trouble developing in the Eurozone:
  • Eurozone growth, inflation accelerate, but recession looms later in year
  • 'Recession is in the air': German economy stagnates in 2nd quarter
  • Eurozone inflation hits yet another record high after big jump
• Recovery signs in Asia after China lifts COVID lockdowns, boosts stimulus:
  • China's factory activity seen expanding at fastest pace in a year
  • China to use effective investment, not flood-like stimulus, to boost economy: state media
  • Japan's factory output zooms as China eases COVID curbs
• BOJ minions think Fed's late response to Biden inflation would put U.S. in recession:
  • BOJ policymakers debated chance of Fed-driven U.S. recession
• ECB minions' scheme to keep Italy's economy afloat may be illegal:
  • ECB nemesis Kerber weighs action against new debt shield
• S&P 500, Nasdaq register biggest monthly gains since 2020
  • Big tech, oil extend Wall Street's mid-summer rebound
  • After steep decline, U.S. small caps tempt investors with cheap valuations

After the Fed boosted the Federal Funds Rate by 0.75% to its new target range between 2.25% and 2.50%, the CME Group's FedWatch Tool projects a half-point rate hike in September (2022-Q3). That's followed by two quarter-point rate hikes in November and December (2022-Q4), with the Federal Funds Rate topping out in a target range between 3.25% and 3.50%. In 2023, the tool anticipates the Fed will be forced to begin cutting rates beginning in May (2023-Q2) as the U.S. central bank responds to more fully developed recessionary conditions, with a high probability of moving earlier into March (2023-Q1). That latter development provides a strong motive for investors to start focusing on 2023-Q1 in setting today's stock prices, which is what the dividend futures-based model indicates happened in this past week.

The Atlanta Fed's GDPNow tool's first projection for real GDP of 2.1% in the third quarter of 2022 suggests the U.S. economy will rebound from its second quarter of negative growth in 2022. Then again, that's a lot like how 2022-Q2 started.

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Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.