Equity markets fell last week following a hotter than expected inflation report. The S&P 500 was down over 4% on Tuesday alone, and off 4.7% for the week. Additionally, bond prices fell as yields rose with the 1-year Treasury topping 4% at one point late in the week.

Unsettling markets was the Consumer Price Index (CPI) report for August, which showed prices up 8.3% year-over-year. This was down slightly from the 8.5% in July, but ahead of the consensus estimate of 8.0%. The core inflation number, which factors out the more volatile food and energy components, also came in ahead of expectations. Core CPI was up 6.3% over last year, well ahead of the 5.9% reading in July, primarily on services inflation and the continued increase in shelter costs.

These numbers served to reinforce the Fed’s aggressive stance and affirmed the rationale behind their announcement today of another Fed Funds rate increase of 0.75%. This increase brings the Fed Funds target range to 3.0% - 3.25%, and last week’s inflation readings increase the chances of additional tightening through the end of the year, potentially pushing the Fed Funds target rate over 4% by the end of 2022.

While additional rate hikes may be a forgone conclusion, what remains to be seen is how much they will slow an economy which seems to have already stalled. We’ve had two quarters of negative GDP growth and a yield curve that’s been inverted for over a month, leading some to argue that we’re already in a recession. Competing with this argument is the fact that we have extremely low unemployment (and 11 million jobs still unfilled), decent corporate earnings, and consumers with relatively strong balance sheets. In the long run these may not prevent a recession but may lessen its severity and/or cause it to be shorter in length.

In either event, both equity and fixed income markets will remain volatile as they attempt to price in the outlook for rates, GDP and corporate earnings. The Fed rarely stops raising rates prior to creating a positive real rate (a Fed Funds rate above the inflation rate), but equity markets are forward looking and will likely factor this in well ahead of the Fed’s last increases. For long-term investors this creates near-term buying opportunities.

In challenging times like these, the key is to focus on your overall financial plan. Emotional, knee-jerk reactions to temporary economic distresses have proven to be counterproductive, and your advisor can help you by making fact-based decisions to keep your plan on track despite inevitable periods of volatility.

Data as of 9/21/2022.