No reason to believe central banks won’t be major driver in 2023
Federal Reserve Board Chairman Jerome Powell and other central bankers have driven 2022 and there’s no reason to believe that they are not going to be an important driver for 2023, says Invesco chief strategist Kristina Hooper. Photo by REUTERS/Evelyn Hockstein Kristina Hooper entered the investment industry in 1995, a year when the Dow and S&P 500 both rose more than 30 per cent, a stark contrast to their respective 9.4 and 20 per cent declines (as of Thursday morning) in 2022. It was also a year after the Great Bond Massacre of 1994, which was caused by central bankers raising interest rates to offset inflation.
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When all was said and done back then, the United States Federal Reserve rate peaked at six per cent in February 1995, double what it was entering 1994. The second-last hike in that cycle, in November 1994, was 75 basis points, the last time the Fed did that until this past June.
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Now, as chief global market strategist at Invesco Ltd., Hooper oversees about US$1.4 billion in assets and finds herself in a similar situation, except stock markets have been tanking and there are few signs central bankers are immediately going to reverse course.
“In ’94, ’95, that cycle happened pretty quickly, within a few months,” she said, adding that central bankers have indicated they’re likely going to stick with their terminal rate, when they get there, for a while this time before cutting.
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Here’s what else Hooper is expecting.
Financial Post: The question everyone wants to know the answer to is when will central banks stop fighting inflation and start cutting rates?
Kristina Hooper: We’re getting to the point now where it’s not just a singular focus on inflation, it’s also balancing the concerns about pushing the economy into a significant recession. We have had this really quite dramatic inversion of the 2s/10s yield curve, even more so for Canada than the U.S. I think there’s less of a singular focus, more of a holistic view of the economy, but certainly with an eye towards getting to normal 25-basis-point rate hikes, but (they are) not yet comfortable with a pause.
FP: Assuming central bankers do tame inflation at some point to some degree, could we end up in a situation not dissimilar to what we used to think was normal before central bankers said two per cent is where we want to be?
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KH: I don’t know if they’d be comfortable with four per cent, but I could see them being comfortable with 2.8 or three per cent, but that doesn’t mean they aren’t going to hit the pause button until we get to three or 2.8 per cent. There’s not going to be conversations about immediate rate cuts, because that’s when you sit and wait for the accumulative effects of what you’ve done, which has been really dramatic and we know there’s a time lag there.
FP: Are there any metrics that investors should be paying more attention to that we typically don’t?
KH: Certainly, job openings because that will give us a sense of where the road will go in the next few months. And we have seen, for example in the U.S., the JOLTS job openings come down, not as much as we’d like, we’re still quite elevated versus where we were pre-pandemic, but they are moving in the right direction. Also, paying attention to consumer inflation expectations. Many strategists become too focused on market-based measures of inflation expectations and what central banks care about are the consumer inflation expectations, and so far, they are relatively good. But, for example, in the U.S., there have been upticks in both the New York Fed reading as well as the Michigan reading over the past couple of months, so that’s something to watch.
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If we really wanted to deconstruct inflation, we’d be looking at all kinds of things like the global supply chain pressure index, which has come down really dramatically. If you look specifically at one item, like container shipping costs, which have come down a lot and that would fall under the goods component. The services component, that’s the real problem, that’s where wage growth is playing a big role, and then, of course, there’s the housing component.
FP: The old adage is just stay in the market, don’t try to time it. Yet every time the Fed opens its mouth, or the Bank of Canada opens its mouth, or a debt number comes out, investors get all excited jumping in and out of the market. Should we be a bit more patient?
KH: Absolutely. What we have always encouraged is taking a long-term view, because humans can be notoriously bad at market timing and so for being well-diversified and getting in for the long run can often result in the best outcome. Having said that, certainly there are those who are very interested in how they should be positioned tactically. But at the end of the day, we really strongly encourage that one takes a long view of investing because that tends to be when the bumps and the volatility can be smoothed out, especially if one has a well-diversified portfolio.
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FP: Going into next year, how should we be positioned?
KH: Right now, defensive, but with an eye towards a market recovery that could be happening quickly. Certainly, you still have equity exposure, but a more defensive bent with large exposure, so larger-cap, low volatility if one is looking at factors, and a preference for the more defensive sectors in the stock market. Within fixed income, a preference for sovereign and investment-grade credit. Investment grade is a component of a portfolio that can really stay with you and be overweight as you transition into a more positive market environment for risk assets. Then, of course, you’d pivot into a less-defensive stance, a more risk-on stance. But that’s not going to happen until a Fed pause appears imminent. That’s when we’re likely to see what I’ll call a regime change from a defensive posture to a more risk-on posture.
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Recommended from Editorial Investor playbook: a tale of two very different halves could have a happy ending 23 investing and personal finance thoughts for what’s to come in ’23 FP: So we’re back to watching rates and inflation then.
KH: Let’s face it, the Fed and other central banks have driven 2022 and there’s no reason to believe that they are not going to be an important driver for 2023. Of course, it’s just different questions. The big questions as we enter 2023 are when are they going to hit the pause button? What the terminal rate is going to be? After that, the big question on investors’ minds will be when will they start cutting? But first things first, and I do think that the stock market recovery is likely to be unleashed in advance of or concurrent with a Fed pause.
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Article content I don’t think it will be a strong recovery, because the timing is unusual this time, because we had this very compressed business cycle. We have economies just entering a downturn or recession, whatever happens, at the same time that stocks are likely to start moving upward. What tends to move stocks up is rate cuts, but I think a pause will do it. There will be that counterbalancing force of earnings downgrades likely continuing, so it’s not going to be something that’s going to start ripping as the Fed hits the pause button. I don’t expect that. I think it will be a more modest stock market rally because it will be tempered by significant earnings downgrades.
This interview has been edited and condensed.
• Email: aholloway@postmedia.com
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