Fed’s Rate Hike Pause and the Prospect of Hard Economic Landing: What It Means for Investors

On September 20th, the Fed refrained from another interest rate hike, keeping it within the 5.25 – 5.50% range. This decision was made despite inflation surpassing the expected 3.6% forecast by 0.1% in August. The central bank’s preferred inflation measure, the core CPI, remained in line with expectations, at 4.3% over the year.

By maintaining the current interest rate, the Fed is relying on the lag effect of previous hikes to start working rather than causing further instability in the banking sector. However, there are concerns that the lag may overcompensate. Fed Chair Jerome Powell has hinted at the possibility of a ‘soft landing’ being achievable, but history shows that such outcomes are rare.

Given the depleted state of household savings, a soft landing seems even less likely. The bottom 80% of households have returned to their pre-lockdown savings level of March 2020, according to Bloomberg. The current federal funds rate was within the 0.00 – 0.25% range until the new hiking cycle began in March 2022, creating a macroeconomic landscape ripe for a hard landing.

In this environment, long-term investments such as value stocks are becoming more scrutinized. Value stocks, representing companies trading below their intrinsic value, have solid fundamentals and are less likely to fall far in a hard landing scenario. The market spreads, expressed by price-to-earnings (P/E) ratios, have increased this year, indicating a shift towards value investing.

The latest surge in the 10-year Treasury yield to 4.55%, the highest level since October 2007, suggests that a rebalancing towards value stocks is imminent. Investors are taking the Fed’s “higher for longer” message seriously, with a 40% chance of another rate hike by year’s end.

In this economic environment, long-term investments in discounted value stocks are increasingly viewed as a potential remedy. The anticipation of a hard landing and the shift towards value investing indicate significant changes in the investment landscape, and investors must adapt their strategies accordingly.