How Much Higher Can Rates Go?

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Inflationary dynamics continue to surprise to the upside, and markets now expect the Fed to pursue one of its most aggressive rate hiking campaign in years. U.S. Treasury yields continue to move higher as well. We think we’ve seen the biggest moves higher in yields, but as long as inflationary pressures continue to surprise to the upside, interest rate volatility will likely remain. We still think the 10-year Treasury yield can end the year between 2.75%-3.25%, but we acknowledge there are risks to the upside.

Last week’s higher than expected inflation report was a game-changer for the Federal Reserve (Fed) and bond markets. With inflationary pressures continuing to run much hotter than the Fed’s 2% target, an even more aggressive rate hiking campaign was priced into markets. Markets are now expecting at least a 75 basis point (bp) increase in its short-term interest rate at this week’s meeting and nearly another 100 bp of hikes in the two remaining meetings this year. Moreover, markets expect the fed funds rate to get to 4.5% by early next year.

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September's Calendar Cruelty for Stocks

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The difficult 2022 for stocks may not get much easier because as we now wait for better news on the inflation front, we have to contend with a seasonally weak month of September. While we got some welcome news in Friday’s jobs report, more evidence of falling inflation will take time to materialize. The good news is a seasonally strong fourth quarter is right around the corner. If history is a guide, midterm elections may provide an added late-year boost.

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Getting Job Market Back Into Balance

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Federal Reserve Chairman Jay Powell reiterated his warning that getting inflation under control will require some pain. Powell is likely making these warnings based on the arcane, clunky relationship between inflation and unemployment. The key to getting the market back into balance is a bigger labor force, and the economy is starting to experience a larger labor force as individuals come off the sidelines and rejoin the job market.

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Earnings Recap: Still Hanging In There

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Earnings growth of 6-7% doesn’t sound very exciting, but given the challenges corporate America has faced, we consider the nearly-complete second quarter earnings season a resounding success. The numerous challenges last quarter included a slowing economy, intensifying inflation pressures, ongoing global supply chain disruptions, and a surging U.S. dollar. Still, corporate America delivered the type of upside investors have grown accustomed to in much easier economic environments.

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