The three things I would tell my clients this week:
The Fed will probably pause rate hikes, for now. This doesn’t necessarily mean that it has stopped hiking. Nor that it will cut anytime soon.
Whether the Fed will pause, or slightly hike further is irrelevant. Money supply is the tightest it has been for years, and will most likely continue to tighten further in the next few months, even if the central bank doesn’t produce another rate hike in this cycle.
The question isn’t whether rates will tighten a bit more. The question is how many investors, businesses and consumers are really ready for a credit crunch.
To hike or not to hike. That is definitively NOT the question.
For four hundred and twenty three years, Hamlet, Prince of Denmark, has presented audiences with the ostensibly ultimate dilemma: To Be, or Not To Be. This monologue is considered the Shakespearean epitome of philosophy, a journey through the inner depths of existence. Is it more noble to quietly suffer life and its pains, or to be bold enough to end everything immediately? What never ceases to amaze me is how great a writer Will Shakespeare of Stratford-Upon-Avon was, how well he presented his argument, that in more than four centuries, almost no one called it out as a false dilemma.
Shakespeare is great for philosophy. However, as a Greek, I’ll let you in on a little secret about philosophy. Most of it is about abstract, non-real life dilemmas, mostly a play on words. Schrodinger’s cat is perfectly alive, until we decide it isn’t. Achilles will simply outrun the tortoise. The Ship of Theseus gets the same number of visitors whether the planks are new or old.
These “thought experiments” are no more than a simple illustration that languages and mathematics are flawed. And most try to boil complex situations down to binary outcomes.
It is the same when thinking about interest rates. At 5%+ the question isn’t whether rates will tighten a bit more. The question is how many investors, businesses and consumers are really ready for a credit crunch.
This week, the FOMC will decide whether it will hike interest rates once more, or whether it will pause. Traders and investors, who are faced with the dilemma of whether the Fed will hike or not, face, pretty much, the same situation as Hamlet: A false dilemma.
Fed officials are probably fretting about what sort of signal they will give to markets. Hike, and calm markets by telling them this is (probably) the last one? Or pause, and risk traders believing that rate cuts are imminent?
The dilemma seems simple enough.
But truth is, it doesn’t matter. Fed officials have been explicit that at 4.9%, the inflation number is very far from their target and will continue to press on. Unemployment remains low and core consumption expenditure continues to rise. Some want a pause, some a hike, and if anything is certain is that we are seeing fissures between members of the rate-setting committee.
Ultimately, whether we have one more rate hike ahead of us, or two, or even none, is largely irrelevant from a long-term investing perspective. Money is the most expensive it’s been for a long time, and will likely become even more so. A generation of investors hasn’t experienced anything like it. Companies made decisions for years, assuming that the global debt burden and secular stagnation would keep rates permanently low.
Yet that world view has now collapsed. Credit conditions will most probably continue to tighten for the next year, as the more recent hikes have yet to take effect. Rates are bound to go higher, Bank credit standards are also tightening, a result of the recent banking crisis. And a deluge of US credit issuance, following the lifting of the debt ceiling, will probably push yields higher.
This means that companies who relied on cheap money more than a clever business plan, will find themselves under pressure. Some will fail. It means consumers will be forced to become more frugal.
But most importantly, it means that fund managers who saw the world like Hamlet, “Risk on or Risk off”, will have to adapt to a more complex environment. Those who get it, have a chance at beating their benchmarks. Those who don’t? Well, “Not to Be” might be the option they will be left with.