iCapital Market Pulse: Amid renewed Fed hawkishness recession risks might be worth hedging
April 7, 2022 | Anastasia Amoroso
The FOMC minutes suggest a more hawkish approach than markets have priced in and the risk of a consumer-led recession is rising. Equity returns are therefore likely to be muted at best over the coming year, and we continue to advise layering in some hedges and adopting a more defensive portfolio stance.
Enjoy the rally, but perhaps don’t get too comfortable with it—that was our message of caution last week. And this week has illustrated why investors need to adopt a more defensive stance. There are two main reasons: first, the U.S. Federal Reserve (Fed) is going to be a persistent headwind for equities for the time being and, second, rising recession probabilities are not yet priced in.
Parallels to the seventies do not bode well for equities
Just when the markets seemed convinced that they had priced in maximum hawkishness from the Fed—with the Fed funds rates expected/projected to rise to 2.5% by the end of 20221—it has signaled it will do more. This week, the Federal Open Market Committee minutes revealed the Fed’s intention to start using balance runoff and quantitative tightening (QT) tools as soon as its May meeting, somewhat sooner than markets expected. Notably, the minutes allowed for the sale of T-bills if the maturities in certain months were below certain caps and discussed outright sales of mortgage-backed securities once the runoff is well under way.2 As long as inflation is elevated and shows no signs of abating, the risk from a market perspective is that the Fed will err on the hawkish side. So, for the time being, expect the Fed to be a persistent headwind to equities at best. At worst, it risks repeating the 1970s.
