(2-minute read) |
All eyes are on the next few series of inflation and labour data as it will determine the next course of action for the Fed. The recent US labour data release has shown a decline in the unemployment rate from 3.5% to 3.4% (economist expectations were at 3.6%). This data will make the Fed believe that their successive hikes have not damaged the economy and will continue to do so to get inflation down sooner.
Market participants are of conflicting views, with three main camps. The first camp arguing for a soft landing is winning, with positive economic data and lower inflation. The second camp believes that deflation and recession are on the horizon, with the numbers taking time to trickle into financial data. The final group of just a tiny few are calling for a hard landing induced by policy error. It will occur when the Fed gets hasty and hikes excessively on better-than-expected economic data, only to blunder and triggers a recession.
The Bank of Canada’s recent meeting resulted in a small rate hike but signalled a temporary pause to let more economic data seep in for policymakers to get a clearer picture. We believe the Fed should follow suit, as there is no need to front-run already declining inflation. Using lagging indicators to dictate policies that affect the economy months in the future is a recipe for disaster.
The critical question is how we should position ourselves considering these main scenarios that could play out. All roads lead to lower rates in the next few years. The interest rate trajectory for each of the scenarios is as follows:
- Soft landing – if inflation continues to go down to the target, rates will reverse downward to ensure that inflation does not undershoot by 2%.
- Hard landing – if the economy starts to give way, the Fed will have no choice but to begin easing measures as inflation and the economy plummets.
- Soft landing turned hard landing – There is an increasingly higher risk that the Fed makes a policy error by acting too hastily, turning the soft landing into a recession.
In times of high volatility and uncertainty over near-term economic data, it is prudent to keep the bulk of your portfolio in cash and focus on trades that really matter.