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Investment Management

Quarterly CIO Commentary – Q4 2022

Rate hikes, global slowdown may shape remainder of year

As we enter the last few months of the year, the U.S. economy looks very different than it did when 2022 began. At the time, the Federal funds rate, which influences the interest rates consumers and businesses pay on debt, was near zero, fueling a booming housing market. Consumer spending on goods was still high, while restaurants and the travel industry looked forward to more consumer spending on services once pandemic restrictions lifted further.

Since then, inflation has soared to a four-decade high and remains mostly persistent, causing the Federal Reserve to raise the Federal funds rate five times from March through September, with two more rate hikes anticipated before the end of the year. The housing market is already feeling the impact of higher interest rates, with home prices down about 5% since their May peak and some predicting that they may fall another 20% by mid-2023.

As the Fed and other central banks worldwide continue to raise rates, U.S. and foreign economies will slow further. With this in mind, BOK Financial Chief Investment Officer Brian Henderson explains what’s ahead for the remainder of the year.

What are the main domestic factors that will drive U.S. economic conditions in the fourth quarter?

The biggest domestic factor is the Fed continuing its monetary tightening campaign to get inflation under control. They’ve already raised the Federal funds target rate to between 3% and 3.25% and, so far, we haven’t seen a dramatic slowing in economic growth. Inflation remains high on a year-over-year basis. However, the Fed is guiding the target rate to around 4.375% by the end of this year, with one more 0.25% hike planned for early 2023.

We’ll see if the Fed is actually able to hike rates as much as that, but if they do, it’s going to slow demand. Mortgage rates, for example, are well above 6.5% now for a 30-year conventional mortgage. The demand for new homes is already slowing as a result, and it’s going to slow even further. Meanwhile, businesses may be hesitant to make any expansions because of the higher cost of borrowing money and uncertainty about where the economy is heading. Companies’ profit margins will also be under pressure because they will no longer be able to pass on higher costs to consumers without reducing demand.

Another major event this quarter will be U.S. midterm elections. Based on current polls, it looks like the Democrats will likely maintain the majority in the Senate but are likely to lose the majority in the House, which would mean a split Congress. If that happens and there are more conservative policies coming from Washington, the stock market might have a more positive outlook, particularly on inflation.

What are some factors that may drive down global growth in the fourth quarter and what are some ways that such a slowdown would impact the U.S. economy?

Inflation is a worldwide problem, so what’s happening with global economies is similar to what’s happening in the U.S. Approximately 70% of foreign central banks are raising interest rates, which means that those overseas economies are also on a slowing path.

That said, there are some unique situations in Europe and in the U.K., where they are not only experiencing inflation but also energy supply issues and other effects from the war in Ukraine. The Bank of England and the European Central Bank are not hiking rates as fast as the U.S. Fed, so it’s lowering the value of the British pound and euro relative to the U.S. dollar. This lower value doesn’t help them when they are importing energy with these currencies. Altogether, Europe and the U.K. are in more of a stag flationary environment of high inflation and weaker growth.

In turn, U.S. businesses that export to the U.K. and Europe are negatively impacted because their goods have become more expensive to these countries, which reduces demand. Yet the fact that U.S. natural gas providers are shipping natural gas to Europe is a positive for the U.S. energy sector.

Finally, another major event in the quarter will be the 20th National Congress of the Chinese Communist Party, which opens on Oct. 16. The financial markets will be looking for policy changes to be announced. For example, are they going to relax some of the pressure they’ve been putting on the property market? Are they going to relax the zero-COVID policy? Are they going to announce new infrastructure investments?

What is the outlook for bonds and equities during the quarter?

In the very short term, stocks haven’t found their footing yet as valuations are under more pressure due to higher long-term interest rate expectations. The next leg will be a hit to earnings per share (EPS) from companies' lower operating margins. When the economy slows, high-grade bonds will start to perform better and go up in price.

What are some potential economic upsides?

I believe the Fed’s rate hikes will be successful in getting inflation under control. That will help bring down long-term interest rate expectations, which will eventually help stocks and will mean that people’s dollars will buy more.

There also are some positives in terms of income. Interest rates have gone higher, so people are now earning higher interest on their savings accounts, CDs and bonds. Wages and Social Security cost-of-living adjustments will also increase.

All in all, U.S. consumers and corporate balance sheets are stronger heading into a potential slowdown. And so, if we’re headed for a recession — and the odds of it happening have increased — perhaps it will be a shallow one.


Brian Henderson
This report was prepared by J. Brian Henderson, CFA, Chief Investment Officer for BOK Financial.