THE FEDERAL RESERVE

Fed Set for Late 2022 Fight Over Rate Hikes

By Josh Rohauer, Portfolio Manager

THE FEDERAL RESERVE

Fed Set for Late 2022 Fight Over Rate Hikes

By Josh Rohauer, Portfolio Manager

The debates over rising inflation and what’s holding back employment will get hotter in 2022 as the Federal Reserve considers whether and when to raise interest rates. In Horizon’s opinion, the important question is this: Which mandate will the Fed focus on in the second half of next year – price stability or maximum employment?

Taking what the Fed says at face value, we believe the Fed’s focus will be on the state of the labor market, more so than on inflation.

Chairman Jay Powell continues to emphasize that the United States is falling short of maximum employment, despite the recovery. Not only that, but given the social unrest of the past year, Powell is making a point of emphasizing unemployment levels for minorities as a key performance indicator of Fed policy.

The rate of unemployment among Blacks, for example, is almost double that of whites.

It’s still a dysfunctional American job market. In short, workers are desperately needed, but helping hands are hard to find.

There are currently 6 million fewer workers compared to pre-pandemic levels.1 And yet businesses say the response to their job openings – currently at a record 10.4 million – is tepid. Americans appear to know that jobs are widely available, judging by the surge in “jobs plentiful” sentiment collected during the Conference Board’s monthly surveys.

Some Fed watchers may point to the unemployment rate as evidence that the Fed has achieved its maximum employment mandate and should begin raising rates. But we believe that’s not enough to assess the Fed’s next step on rates, in large part because Powell told Congress late in September the unemployment number is misleading.

“The unemployment rate was 5.2% in August, and this figure understates the shortfall in employment, particularly as participation in the labor market has not moved up from the low rates that have prevailed for most of the past year.”4 

We believe that if the Fed is going to focus on the composition of the labor market to drive its rate decisions, then we should also focus on that particular measure.

As for inflation, Powell told Congress in late September that “near-term supply constraints are restraining activity,” meaning supply chain bottlenecks and factories closed due to the pandemic are to blame for the price jumps as certain products become harder to secure.2 

Raising interest rates, in our opinion, would seem to be counterproductive to combat what is a fitful economic reopening.

What is helpful on the inflation question is the current decline in the number of Covid cases worldwide. It provides an opportunity for many factory and shipping problems to be ameliorated. And should that happen, we, like the Fed, believe prices for goods will stabilize or begin to fall, helping Powell make progress towards the central bank’s “price stability” mandate.

As we look to 2022, we believe investors should focus on three key points. One, we expect the Fed to remain more dovish than the consensus through 2022 to ensure that the economic recovery takes hold.

Two, we are focusing on the composition of the labor market as a driver of Fed policy and not focusing on a single, headline metric.

Lastly, all else being equal, a dovish Fed could be a positive support for equity markets that are facing several earnings headwinds.

As for the Fed tapering its asset purchases, we don’t believe this should have a significant impact on the level of bond market yields. There are too many investors, both overseas and in the U.S., searching for fixed-income investments with positive yields. As the Fed steps out, we believe other investors are likely to step in.

1 https://www.federalreserve.gov/newsevents/speech/powell20210827a.htm
2 Chairman Powell opening remarks to Senate Committee on Banking, Housing, and Urban Affairs; Source: Federalreserve.gov

The commentary in this report is not a complete analysis of every material fact in respect to any company, industry or security. The opinions expressed here are not investment recommendations, but rather opinions that reflect the judgment of Horizon as of the date of the report and are subject to change without notice. Opinions referenced are as of the date of publication and may not necessarily come to pass. Forward looking statements cannot be guaranteed.

We do not intend and will not endeavor to provide notice if and when our opinions or actions change. Horizon Investments is not soliciting any action based on this document. This document does not constitute an offer to sell or a solicitation of an offer to buy any security or product and may not be relied upon in connection with the purchase or sale of any security or device.

Information has been obtained from sources considered to be reliable, but the accuracy and completeness cannot be guaranteed. Horizon Investments and the Horizon H are registered trademarks of Horizon Investments.

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