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Financial Markets Attempt to Stabilize

September 9, 2022

Last Week in Review: Financial Markets Attempt to Stabilize

After several weeks of higher rates and lower stocks, the financial markets stabilized a bit. Let's walk through what happened and look into the week ahead.

When Words Don't Matter

"I am more focused on if balance sheet reduction will affect liquidity in markets than impact on fed funds rate. Fed should contemplate selling Mortgage Backed Securities (MBS)" Cleveland Fed President Loretta Mester, September 7, 2022.

This quote is reminiscent of the Fed jawboning that has hurt stocks and elevated long-term rates throughout the year.

However, last week it had no effect as the bond markets did say enough is enough with rates improving a touch year over year.

"The outlook for future economic growth remained generally weak, with contacts noting expectations for further softening of demand over the next six to twelve months." Fed Beige Book September 7, 2022.

The Fed Beige Book is gathered by the Federal Reserve Bank of San Francisco from districts around the country and represents comments from different communities. One of the big takeaways from the "Beige Book" is this quote where people across the country are expecting a further slowdown in economic growth or elevated threat of a recession. They also expect demand to decline, which is what the Fed wants as less demand means lower prices or lower inflation.

Lower Oil Prices Means Lower Inflation

The price of a barrel of oil hit $82, well off the 2022 highs of $130 and the lowest levels since February. The main drivers for the consistent drop in price are elevated global recession fears and the U.S. Dollar trading at the highest level in decades, thanks to the tough talk and action by the Federal Reserve. Should Oil prices continue to decline, we should expect headline inflation, where energy is a main input, to decline as the Fed wants.

The ECB Goes BIG

Last Thursday, the European Central Bank (ECB) raised their benchmark deposit rate by .75% matching the largest increase in their history. The Euro region is struggling economically and will also be challenged to avoid a recession. If Europe and other countries around the globe struggle, it makes our U.S. Dollar and Treasury yields look relatively attractive, meaning, there will be a limit to how high long-term rates will go.

Bottom line: Much like the Fed did in the first half of the year they are "jawboning" the market by saying they will continue to raise rates and be very aggressive in doing so. The only rate they can raise is the Federal Funds Rate. With recession fears escalating there will be a limit to how high interest rates will go and we are watching the June rate peak as a ceiling for 2022.


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