The Federal Reserve will stay hawkish — what will that mean for markets?

Time to read: Minutes

Stocks and bonds have pulled back since the Fed clarified its commitment to fighting inflation. Despite volatility, we believe equities will stay within a broad trading range and not retest earlier lows. Rising yields, particularly among spread assets, should make bonds appealing compared to equities.


  • Fed Chair Jerome Powell’s Jackson Hole speech dispelled any notions about an imminent pivot toward moderating rate increases. Instead, he reaffirmed that the Fed is committed to higher rates for as long as it takes to bring down inflation.
  • Even though Powell said nothing new or surprising, equities fell steeply, raising questions about how much further they might fall as financial conditions tighten.
  • Equities could take another leg down if earnings weaken, though with expected economic slowing in 2023, rates are not likely to drive a further equity pull back or cause PEs to decline.
  • The bond market reaction to Powell’s speech was not as severe; yield spreads didn’t change much and the long end of the U.S. Treasury curve was fairly stable.

Closing the books on a secular trend

The transition from the era of steadily falling rates and low inflation has been underway for some time. Yet, the emergence of a new regime hasn’t seemed that pronounced until the last year or so, as the impacts of the Covid pandemic have faded. In recent years, because inflation still was not a threat, the Fed was able to focus on unemployment and could quickly pivot from rate increases back to rate cuts. This time it’s different: with inflation seriously rising priorities have changed, and the Fed is focused on keeping inflation expectations from becoming entrenched in wage and price decisions.

Labor market weakness and economic slowdown are unlikely to prompt a policy pivot unless inflation significantly decreases as a result. As Powell noted, collateral damage to businesses and employment “…are the unfortunate costs of reducing inflation.” Expectations remain in place for a 75-basis-point (bp) rate increase in September, with six more hikes through March 2023, a first rate cut in November 2023 and a second cut in January 2024.

Target rate probabilities for upcoming FOMC meetings
Target rate probabilities for upcoming FOMC meetings

Source: CME Fedwatch; orange = highest probability, blue = second highest probability, data as of 9/2/2022.

Signs of slowing are gathering. The second reading of 2Q22 real GDP improved from –0.9% to –0.6%, though still showing contraction for a second straight quarter. The improvement was largely due to an upward revision of consumer spending, which bodes well for the economy but could embolden the Fed to keep raising rates.

The yield curve remains inverted. In recent weeks, the two-to-ten spread has been negative but fairly stable, ranging between –20 and –40 bp. August nonfarm payrolls added 315,000 new jobs, a pullback from July’s 526,000 pace while still pointing to labor market tightness, as the unemployment rate rose to 3.7%. August CPI data will come out ahead of the September FOMC meeting, but without a dramatic downshift are unlikely to alter the rate decision.

While the Fed and other central banks are committed to bringing down inflation, a quandary surfaced at the Jackson Hole symposium as to how much inflation can be trimmed before the economic and social pain becomes unacceptable. Consensus seemed to be that inflation could be brought down to around 3% without too much disruption, but that going from 3% to 2% would greatly increase recession risks and inflict too much pain on the lower income quintiles of the population, who shoulder the brunt of the impacts from weaker labor conditions and higher consumer prices.

Also, certain short-, intermediate- and long-term trends point to a higher cost economy in the months and years to come. Until a new equilibrium is established, bringing inflation down to the Fed’s 2% target could be challenging.

In the near term, crude oil markets have shown an atypical dynamic this year that likely will increase prices during heating season. Typically, in the first half of the year as the weather warms, drawdowns slow and supplies build. This year, sanctions against Russia for invading Ukraine have disrupted supply and led to net 1H22 drawdowns — supply will be lower as heating season begins.

U.S. stocks of crude oil and petroleum products
Weekly count, thousands of barrels
U.S. stocks of crude oil and petroleum products

Source: U.S. Energy Information Administration, data as of 8/31/2022.

Over the likely span of the current rate cycle, manufacturers seeking to mitigate their vulnerability to global supply-chain risks will be adding onshore capacity, which likely will entail higher labor costs. Eventually, those costs should be mitigated as greater supply certainty leads to more investment in productivity enhancing technology, but cost pressures could prove sticky while the Fed is in tightening mode.

Longer term, housing costs have put home ownership, and even renting, out of reach for many recent entrants into the workforce. In June, higher mortgage rates made homeownership less affordable and slowed home price growth. That could help ease inflation, but also could push up rents. Later, as younger cohorts seek to build families, they could reignite home price pressures.

Earlier in the third quarter, some investors began to believe the Fed’s aggressive rate increases were done and that, starting in September, the Fed would reduce the size of hikes before cutting rates in 2023. Those beliefs spurred an equity market rally that for a time seemed poised to recoup year to date losses.

Powell’s speech dispelled the notion that the Fed might soon moderate its policy stance, and set the stage for an equity pullback, with the Dow Jones Industrial Average falling about 1,000 points. While the equity market reaction was intense, it aligned with historical precedent. In market-bottom episodes since 1922, bear-market rallies have averaged 16% before pulling back. The most recent market rally reached about 16%, and thus represented a likely retracement point.

Stock investors may be shifting to a “good news is bad news” mentality, in which good economic news is seen as a harbinger of bigger Fed rate hikes. For example, recent JOLTS data, which showed the labor market remains tight, prompted another equity pullback. Despite volatility, we believe equities will stay within a broad trading range and not retest earlier lows. Equities could take another leg lower if earnings weaken, but for now fundamentals seem intact and imply market resilience.

S&P 500 index: year over year growth rates
S&P 500 index: year over year growth rates

Source: I/B/E/S data from Refinitiv, as of 9/2/2022.

As of September 2, 2022, Refinitiv estimated 2Q22 S&P 500 earnings to have grown 8.5% year over year, with 5.1% expected for 3Q22 and 6.3% for 4Q22. Sector earnings estimates ranged widely, with an average of seven of 11 sectors expected to deliver positive growth in each quarter. Forward PEs had adjusted; the 12-month forward PE was 17.1, down from 18.1 in August. If economic growth slows as expected in 2023, then we would expect real yields to fall, which makes it less likely that earnings multiples will decline significantly.

Fixed income outlook

Bonds did not react to Powell’s speech as severely as equities did. Early in the following week, there was some “bear flattening,” i.e., shorter maturity yields rising faster than longer maturity yields, but the long end of the U.S. Treasury curve remained fairly stable. In our view, rates are not likely to cause a further equity pullback. The equity shakeup following the speech didn’t change yield spreads much; investment grade credit spreads widened only about 8 bp.

Shorter-term Treasury yields are likely to increase as investors reassess how high rates could go. Generally, higher yields should make fixed income strategies more appealing compared to equities. Equity weakness has not yet impacted high yield credit spreads, which recently moved from near 500 toward 600 bp. We expect spreads to remain volatile but not exceed 800 bp.

ICE BofA U.S. high yield index option-adjusted spread
Not seasonally adjusted
ICE BofA U.S. high yield index option-adjusted spread

Source: Ice Data Indices, LLC, ICE BofA U.S. high yield index option-adjusted spread, retrieved from FRED, series/BAMLH0A0HYM2, September 6, 2022. The ICE BofA Option-Adjusted Spreads (OASs) are the calculated spreads between a computed OAS index of all bonds in a given rating category and a spot Treasury curve. An OAS index is constructed using each constituent bond’s OAS, weighted by market capitalization. The data represent the ICE BofA U.S. High Yield Index, which tracks the performance of U.S. dollar denominated below investment grade rated corporate debt publicly issued in the U.S. domestic market. Investors cannot invest directly in an index.

Rate volatility is likely to remain elevated; the ten-year U.S. Treasury yield has been ranging around 3%. At this point, ten-year rates are being driven not just by Fed policy but also by inflation expectations in Europe, as we saw in mid-August, when a surge in German PPI pushed up U.S. yields. With a Eurozone recession looming, the European Central Bank may not have the Fed’s latitude to tighten rates policy. This could make Europe another source of inflation pressures to which the Fed will have to respond.


Past performance does not guarantee future results. This piece has been prepared by Voya Investment Management for informational purposes. Nothing contained herein should be construed as (i) an offer to sell or solicitation of an offer to buy any security or (ii) a recommendation as to the advisability of investing in, purchasing or selling any security. Any opinions expressed herein reflect our judgment and are subject to change. Certain of the statements contained herein are statements of future expectations and other forward-looking statements that are based on management’s current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Actual results, performance or events may differ materially from those in such statements due to, without limitation, (1) general economic conditions, (2) performance of financial markets, (3) interest rate levels, (4) increasing levels of loan defaults, (5) changes in laws and regulations and (6) changes in the policies of governments and/or regulatory authorities. The opinions, views and information expressed in this commentary regarding holdings are subject to change without notice. The information provided regarding holdings is not a recommendation to buy or sell any security. Fund holdings are fluid and are subject to daily change based on market conditions and other factors.

The distribution in the United Kingdom of this presentation and any other marketing materials relating to portfolio management services of the investment vehicle is being addressed to, or directed at, only the following persons: (i) persons having professional experience in matters relating to investments, who are “Investment Professionals” as defined in Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (the “Financial Promotion Order”); (ii) persons falling within any of the categories of persons described in Article 49 (“High net worth companies, unincorporated associations etc.”) of the Financial Promotion Order; and (iii) any other person to whom it may otherwise lawfully be distributed in accordance with the Financial Promotion Order. The investment opportunities described in this presentation are available only to such persons; persons of any other description in the United Kingdom should not act or rely on the information in this piece.

The Capital Markets Authority and all other Regulatory Bodies in Kuwait assume no responsibility whatsoever for the contents of this presentation and do not approve the contents thereof or verify their validity and accuracy. The Capital Markets Authority and all other Regulatory Bodies in Kuwait assume no responsibility whatsoever for any damages that may result from relying on the contents of this presentation either wholly or partially. It is recommended to seek the advice of an Investment Advisor. Voya Investment Management does not carry on a business in a regulated activity in Hong Kong and is not licensed by the Securities and Futures Commission. This insight is issued for informational purposes only. It is not to be construed as an offer or solicitation for the purchase or sale of any financial instruments. It has not been reviewed by the Securities and Futures Commission. Voya Investment Management accepts no liability whatsoever for any direct, indirect or consequential loss arising from or in connection with any use of, or reliance on, this insight, which does not have any regard to the particular needs of any person. Voya Investment Management takes no responsibility whatsoever for any use, reliance or reference by persons other than the intended recipient of this insight. Any prices referred to herein are indicative only and dependent upon market conditions. Past performance is not indicative of future results. Unless otherwise specified, investments are not bank deposits or other obligations of a bank, and the repayment of principal is not insured or guaranteed. They are subject to investment risks, including the possibility that the value of any investment (and income derived thereof (if any)) can increase, decrease or in some cases be entirely lost, and investors may not get back the amount originally invested. The contents of this insight have not been reviewed by any regulatory authority in the countries in which it is distributed. The opinions and views herein do not take into account your individual circumstances, objectives, or needs and are not intended to be recommendations of particular financial instruments or strategies to you. This insight does not identify all the risks (direct or indirect) or other considerations which might be material to you when entering any financial transaction. You are advised to exercise caution in relation to any information in this document. If you are in doubt about any of the contents of this insight, you should seek independent professional advice.

In addition, please be advised that Voya Investment Management is a non-Canadian company. We are not registered as a dealer or adviser under Canadian securities legislation. We operate in the Provinces of Nova Scotia, Ontario and Manitoba based on the international adviser registration exemption provided in National Instrument 31-103. As such, investors will have more limited rights and recourse than if the investment manager were registered under applicable Canadian securities laws.

2022 Voya Investments Distributor, LLC • 230 Park Ave, New York, NY 10169 • All rights reserved.