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Navigating the Coming Storm of Fed Rate Hikes

The Federal Reserve finally raised interest rates. Though widely discussed and anticipated, but this should not diminish the importance of the move.

The decision to raise rates was unanimous – none of the 12 Federal Open Market Committee (FOMC) board members voted against the hike. This in itself is unusual. Also Federal Reserve Chairman Kevin Warsh communicated the hike in such a way that left the door wide open for future hikes. We can only conclude that the Federal Reserve are preparing for a severe bout of inflation.

It is hard to communicate just how much sentiment has shifted in financial markets in the past two weeks.

Between May and the end of August everything seemed calm. Then, in the last two weeks, inflation expectations exploded. Why is this? Since the Hormuz crisis started earlier this year, the US government has been trying every trick in the box to keep markets calm and oil futures prices down. At a certain point though the illusions run out and reality starts to hit. It seems that we have now reached that point. The following chart shows the bets that market participants were putting on rate hikes since Warsh got the job.

What comes next? US government borrowing costs are already under massive pressure due to the chaos in the Middle East. The raise in the Federal Reserve interest rate will aggravate this. The interest rate on a 10-year government bond has crossed 5% which is generally seen as being difficult to sustain. I would not be surprised if it climbed to 6% in the coming weeks as the market prices in serious fuel shortages and more hikes by the Federal Reserve. At a certain point, this will cause a crisis likely in either the mortgage market, the private equity and private credit markets, the stock market or all three.

As noted in last week’s note the Max Otte Multiple Opportunity Fund (MOMO) is well-placed to deal with this set of circumstances. The portfolio is structured to deal with either inflation or a recession – or both. Currently its main defensive investments are its overweight positions in energy stocks and its large holding of precious metals. But we are currently building positions in retail stocks that we believe are both good investments on a value basis and will benefit from any major inflationary or recessionary developments. If a storm is on the horizon, it is often best for ships to find a port. Our intention is for MOMO to provide a port to wait out the coming storm.

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