All the talk this past summer and into the fall has focused on one thing: predicting peak inflation. When would the Fed pivot from an aggressive hawk stance to a more neutral one and then eventually dovish and bring down interest rates? Well, it appears the conversation has shifted, and inflation fears have given way to recession fears.
Market players have a thirst for trying to get ahead of these transitions, but the risk is being too early. Many traders took that risk anyway, and they have lost large sums of money this year. It is very hard to make up for those losses without some much needed help, like Fed liquidity.
So, while the crowd was trying to predict a pivot by the Fed, Fed governors have not once indicated any sort of policy change. We have started to see a few pieces of data that could persuade them to change their view, but there needs to be more of it. Inflation is starting to come down in certain areas, and that is a positive data point.
Market volatility has been on the decline for six weeks, which has me thinking traders are starting to pivot well before the Fed. This makes sense: A recession would have a greater impact on the markets than inflation.
Hence, it appears worries have shifted from high inflation to economic woes. The Fed predicts job losses will start piling up in 2023, which have started already this month. Spending patterns remain robust, but that is likely to change when job losses mount.
But if economic woes trigger selling in the stock market, volatility is not reflecting this. Why? Because we’ve heard recession mentioned so many times. Eventually the mind and body just say, “Fine, give me the recession… I’ll deal with it and move on.”
Without surprises there is no need to panic or rely on buying up index put protection. It’s time to think about the economy and how rate hikes will impact GDP and earnings.