Hard Landing – What does this mean for markets?

Fed has switched up rhetoric from “soft landing” to “hard landing”

For many months, Jerome Powell, the Chairman of the Federal Reserve Board used language such as “soft landing” to describe the economic impacts of persistently high inflation and the Fed’s response of raising rates. Essentially, the Fed sought to taper negative expectations, however, at the same time, it did not expect inflation to remain as high as it has despite aggressively raising rates. Now, the rhetoric has changed, with Powell stating a soft landing has a “narrowed” probability.

Truth be told, the actions that the Fed is currently taking may have a lagged impact before showing up in the real economy and in the inflation print. However, until inflation starts trending towards 2% (the long-term inflation target), the Fed must ensure it is doing all it can to combat inflation i.e., continuing to hike rates aggressively.

The reason for this is that not only does the Fed play an important role in managing the current economic environment, but it must set expectations for the economy. If it does not raise rates aggressively, it sets the expectation that inflation could run rampant. This would have an even more detrimental impact on the broader economy and financial markets than we have seen to date.

What does this mean for markets?

Based on the current data, it is highly likely that the Fed will continue to tighten and raise interest rates further. The implication of this is that “risky” assets, or assets with an uncertain return, will not perform as well. However, most financial participants have already factored further rate hikes into current valuations. Consequently, there is a current dichotomy in terms of how to perceive the market outlook. Either a) inflation will continue to trend in the wrong direction, leading to more-than-expected aggression in rate hikes; or, b) inflation will begin to taper, leading to lower-than-expected rate hikes and potential decreases in rates. 

ETFs to consider: Commodities or inverse bond ETFs

Investors expecting inflation to trend higher may want to consider asset classes that perform well in persistently high inflationary environments. This includes commodities or inverse bond ETFs such as: 

PDBC – Invesco Optimum Yield Diversified Commodity Strategy ETF

• AUM: $7.8B
• 1mo Performance: +8.0%

TBT – ProShares UltraShort 20+ Year Treasury ETF

• AUM: $1.2B
• 1mo Performance: +20.3%

Investors expecting inflation to fall may want to consider asset classes that have sold off more aggressively since they may rebound to a greater degree. This includes equities, specifically in tech and consumer discretionary sectors such as: 

IYW– iShares U.S. Technology ETF

• AUM: $7.8B
• 1mo Performance: -5.2%

XLY – The Consumer Discretionary Select Sector SPDR Fund

• AUM: $13.9B
• 1mo Performance: -3.5%

Data for this article is as of November 7, 2022.

Please note this article is for information purposes only and does not constitute investment advice.