Market soars as Fed hikes rates by 0.75%
The Fed says we're not in a recession, but it sure feels like it
Wednesday, July 27th, 2022
The Market soared on positive economic data and softening talk from the Fed despite poor earnings reports. All indexes rose on the day.
The S&P 500 climbed by 2.62%
The NASDAQ Composite soared by 4.06%
The Dow Jones increased by 1.37%
The Russell 2000 jumped by 2.39%
The Fed raises rates by 0.75% again
This week is perhaps the most important for the Market in a couple of months following June's 9.1% inflation report shocker earlier this month. The main story driving the Market right now is interest rates and what they mean for GDP.
As expected, the Federal Reserve (“the Fed”) hiked interest rates by 0.75% today, matching its historic increase in June. So far this year, the Fed has made four hikes, totaling 2.25% and bringing its target range from between 0.00% and 0.25% to 2.25% and 2.25%.
The Fed expects to raise rates to about 3.4% by the end of the year and 3.8% by the end of 2023.
However, some of the Fed's Governors and Larry Summers, former President of Harvard and Treasury Secretary, believe that the increase doesn't go far enough to curb inflation. They would rather the Federal Reserve induce a mild recession now that would decrease consumer demand rather than risk a deep downturn next year.
In contrast, Federal Reserve Jerome Powell believes the economy, buoyed by low unemployment and stable consumer demand, is strong enough to withstand higher interest rates.
Powell also signaled that the Fed would slow its hike later this year and that he doesn't see the US currently in recession despite negative GDP growth in Q1 2022. But some company CEOs believe we're already in one.
Debating a Recession
Is the US economy contracting? Perhaps.
But does that mean we're in a recession? Perhaps not.
The Bureau of Economic Analysis reports US GDP for Q2 tomorrow, and some economists expect it to be negative, while the forecast shows nearly flat positive growth. A decrease would mark the second successive quarter in which the US economy contracted, which in the traditional sense means that we are in a recession.
But the definition has changed in the past 20 years or so. Economists have sought to redefine a recession from the general rule of two bad quarters to "a significant decline in economic activity that is spread across the economy and lasts more than a few months."
Economists rationalize that the economy is too complex for negative GDP growth to indicate a downturn. In Q1 2022, the negative quarterly GDP growth was attributed to a growing trade imbalance brought on by the US importing far more than it imports.
Under the new definition, no longer is a recession just two-quarters of negative growth, but rather a reading that multiple economic indicators are degrading. Rather economists reason that a recession is a severe decrease in employment alongside contracting consumer demand.
But the US currently still has both employment and consumption growth. So even if Thursday's numbers show a contraction, many economists, including Jerome Powell, will argue that the US is not in a recession. His argument was bolstered today by data showing that the US trade imbalance shrunk in Q2, supported by higher demand for US goods, such as energy.
Why does this matter?
Wall Street has been obsessed with the prospect that if the Federal Reserve raises rates by too much, we will enter a recession or, even worse, stagflation (stagnant growth + high inflation). The data so far has been confusing, but in summary, pessimism and price increases are high, but consumer spending and job growth are keeping pace.
While the Fed may believe that we aren't in a recession, company executives are more pessimistic about the economy, and it's starting to show in corporate earnings and layoffs.
After the Market closed today, Facebook reported its first-ever quarterly drop, sending its shares down, while Shopify announced it would be laying off 1000 employees given headwinds in eCommerce.
While tech has been battered all year, the sector roared back today on comments from Jerome Powell that interest rate hikes will slow in the coming months. But don't let it fool you; tech is in a deep bear market, and the sentiment has bled into the private market. Sidenote: if you're involved in the startup world, you know that the music has stopped, and the good times are over for now.
Corporations are also pessimistic that higher interest rates and high inflation will continue to hurt their businesses. This past week, companies from Walmart to Netflix to Philip Morris reported that higher costs eroded their profits and a strong dollar decreased consumer demand from abroad.
In summary, the Market's movement up today despite rising rates is just a reaction to the Federal Reserve not accelerating rates by even more. And while we may not technically be in a recession (yet), it sure feels like one.