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Forget a Soft Landing, We Have Now Run Out of Runway

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Wednesday, the Federal Reserve hiked interest rates by 75 basis points as expected. It also looks likely now that we will get another 75 bps hike and a 50 bps increase by the end of the year. That puts the “dot plot” at 4.4% by the end of 2022. Meanwhile, the 10-Year Treasury yield has just broached the 3.75% mark.

The central bank’s actions have thrown cold water on any investor still modeling a “soft landing” as a likely scenario in the coming months. The markets have reacted to this interest-rate trajectory as one would expect. So have economic pundits.

The latest hike puts another nail in the housing market. A 30-year fixed-rate mortgage averaged 6.29% with an average of 0.9 points for the week ending Thursday. This is up from 6.02% last week and more than double the 2.88% rate for the same week a year ago.

The August Leading Indicators report also showed the seventh straight month of decline, signaling an oncoming recession. Oppenheimer chimed in that stocks could decline by an additional ~10% if the economy tips into recession. The investment bank reasoned that equities usually fall 30% during cyclical bear markets and the S&P 500 is already off just over 20% for the year. It seems quite possible that we will soon test the June lows for the index in the very near future.

Things are hardly brighter in Europe. The S&P Global Flash Eurozone Services PMI fell to 48.9 in September. This is the lowest level since February of last year when much of the continent was still in quasi lockdown mode. It is also the second consecutive month of contraction in services for Europe. Things will only get worse as winter approaches given the ongoing energy crisis across the pond.

My base scenario is that the Federal Reserve and other events put us in a global recession in the coming months. The central bank is likely to continue to hike rates until the economy and the jobs markets break in order to put the inflation genie back in the bottle. At that point they will be forced to reverse course or “pivot” and start to lower rates to revive the moribund economy. Until then, though, both equities and the economy are going to experience more pain.

So, what is an investor to do?

For me, I continue to have a much higher than normal allocation to cash in my portfolio. I am also getting prepared to buy an investment property or two if asking prices continue to fall. I believe that even if I take out a 6% mortgage, within a year the central bank will have reversed their monetary tightening efforts and I will be able to refinance at a much lower rate.

For those just wanting to park their money for a while, the 2-Year Treasury yields north of 4% for the first time since 2007.

Not exactly exciting investment advice but right now it seems the best course is to keep it simple and keep it safe.

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