The Last Time We Were Here

The Federal Reserve hikes rates – again... The U.S. is leading the inflation charge... Why a stronger dollar matters for stocks... The last time we were here... Putin calls in the reserves... A one-way ticket to somewhere...

We'll start today with the latest news from the Federal Reserve...

This afternoon, the central bank raised its benchmark interest rate by another 75 basis points, as Wall Street was largely expecting.

The move will bring the federal-funds rate range – which most directly matters for banks and then filters throughout the economy – to between 3% and 3.25%. The change makes borrowing costs in the U.S. the highest they've been since before the financial crisis... and marks the first time rates have eclipsed their previous cycle peak since before the dot-com bubble...

Maybe it's just a coincidence?

The Fed's board members, as is a quarterly custom, also published their updated projections for interest rates (the so-called dot plot), gross domestic product ("GDP"), and unemployment through the end of the year and for the next two years...

Here's where it gets interesting...

The projections showed a central bank that is acknowledging a "higher for longer" interest-rate environment... It foresees basically no economic growth this year (a 0.2% rise in real GDP) along with lower inflation but higher unemployment in 2023.

The Fed projects between another 100 or 150 basis points of rate hikes by the end of the year – a full percentage point more than it previously expected – and maybe more increases in 2023, all while not lowering rates until 2024.

In the meantime, its experts think unemployment will rise to 4.4% over the next two years, up from a record-low 3.7%. That's significant news and would mean more than 1 million lost jobs – likely making for a recession that no one can pretend away.

Take these for what they are: projections by a group of people who have gotten a lot wrong the last two years. Still, it's what the string-pullers of monetary policy in the United States are thinking today... and it matters to the markets.

Mr. Market's immediate reaction was to go from a muted positive day to falling hard, fast... The benchmark S&P 500 Index and the tech-heavy Nasdaq Composite Index went from up about 1% before the Fed's policy announcement at 2 p.m. to down 1% just five minutes later.

Fed Chair Jerome Powell spoke soon after. Given his tendency to make conflicting answers to unscripted questions, he took pains to state up front...

My main message has not changed at all since Jackson Hole.

Powell didn't say much new in his opening remarks except that "at some point" the Fed will consider easing rate-hike increases.

In the answers that followed, he did discuss a couple new ideas... One was that "real" rates – even accounting for higher-than-usual inflation – could stay positive for an extended period of time. Another was that the Fed has only entered the early stages of its "restrictive" policy.

In general, Powell gave the impression that the economy is in for tough times over the next year or two, but that inflation far and away is public enemy number one and rates will keep going up to fight it.

In response to a direct question, Powell also didn't rule out a recession – beyond what we may have seen already – saying nobody can know for sure. That's the first time I've heard him say that.

The market didn't want to hear that... After rallying during his initial remarks, once Powell was done talking, the indexes sold off sharply into the close. The S&P 500 and Nasdaq finished down roughly 1.8%, capping a volatile final two hours of trading and adding to recent losses.

A lot of people will parse the pluses and minuses of the Fed raising rates by 75 basis points, its economic projections, and what Powell said or didn't say in his press conference. That's a fine discussion to have – and we may have more tomorrow...

But despite what you might hear today, don't forget the bigger picture... The big story of 2022 – and the ongoing bear market in U.S. stocks – hasn't changed yet.

First, inflation remains a worldwide problem...

And, in response, dozens of central banks are raising interest rates, which will slow the global economy (and hopefully inflation, though no guarantees). But the U.S. is leading the charge, with Powell intent on raising rates "until the job is done," consequences be damned...

At the same time, the Bank of England is looking like it will make a 75-basis-point hike tomorrow from its current benchmark rate of 1.75%, much lower than the Fed's equivalent lending rate... even though U.K. inflation is about 10%.

Many of the world's other major economies are trying to catch up... or are dealing with worse problems, as in the case of Turkey and Argentina, which have inflation rates of about 80%. The uncertainties about high inflation's staying power and concerns about an energy crisis this winter, particularly in Europe, are also lingering in millions of people's minds.

Here's why this context matters, practically, to the stock market...

This connect-the-dots game starts with the U.S. dollar. As we wrote last week, as a result of the Fed raising rates, the dollar has been strengthening versus other major world currencies.

The U.S. Dollar Index ("DXY") rose another half percent to hit a new 20-year high. It remains in a strong uptrend, up 18% over the past year (and trading above its 50-day moving average nearly the entire time)...

Looking broader, with the move today, the Dollar Index hit a level not seen since June 2002.

We're not discounting the fact that 40-year high inflation is eating away at the purchasing power of dollars. But relative to other currencies, the dollar is getting stronger. (For example, the Bank of England started hiking rates from negative territory... and Japan is keeping low rates in place despite its fastest inflation rate increase in eight years.)

Now, in the spirit of using relevant history rather than just any history, let's explore this 20-year high in the U.S. dollar a bit more... and the next important dot in this game: why a strong dollar matters to stock prices.

The last time we were here...

The previous time the U.S. dollar was at current levels was the backside of the dot-com bust and closer to the bottom. But the dollar's value was trending down then, which isn't the best comparison to today. So let's take a look at a better and more useful instance...

The last time the U.S. Dollar Index reached today's levels and was hitting new highs, like today, was in May 2000.

That was just before the S&P 500 topped during the dot-com bubble... and a few months after the Nasdaq Composite Index peaked (and around the same time tech stocks had a classic bear market rally).

So, not good company...

Plus, as we shared last week, the dollar and the S&P 500 are now inversely correlated. When one has gone up this year, the other has gone down and vice versa – all year long... If you take nothing else from today's Digest, make it that relationship...

This is driving the stock market's direction...

As Stansberry NewsWire editor C. Scott Garliss wrote on Monday, the dollar – and associated bond yields, which are also rising to new highs lately – will determine the near-term direction of the stock market...

The Fed's primary weapon in its fight against inflation is to hike interest rates to increase the dollar's buying power. So, by increasing yields, the central bank is making U.S. sovereign debt a more attractive investment.

You see, 10-year U.S. Treasurys are long-considered one of the safest investments in the world. That's because our government has never defaulted on its obligations. And when money managers at home and abroad see the payout potential increase, they must convert into dollars to buy U.S. sovereign bonds.

The process makes the greenback increasingly scarce... As more individuals and asset managers clamor for the same resource, its value rises. That's important from an inflation standpoint. A more valuable dollar means it should take less of them tomorrow to buy the same amount of a particular item... like, say, a gallon of gasoline, as it did today. In other words, a stronger dollar weighs on inflation.

Yet, until there's more certainty about the Fed's end goal with interest rates, the yield on sovereign debt is likely to head higher.

So the Fed continues to hike rates – and to higher levels than those in other major economies. This raises the relative strength of the dollar... and Treasury yields, too. This all means the headwinds blowing in the face of U.S. stocks haven't eased yet.

Also remember, a good chunk of S&P 500 companies' revenues come from abroad. Inflation is happening there, like here, but a stronger dollar eats into potential profits while the global economy will be slowing down.

As Scott and his colleague Kevin Sanford shared in another piece of research on the dollar in our free NewsWire service, this scenario is fuel for the potential "earnings recession" we talked about yesterday. As they wrote...

Keep in mind that 30% of S&P 500 companies' earnings are generated abroad. This means that a stronger dollar serves as a headwind for profits. This results in downward earnings revisions – and a likely decline in markets in the near term.

Eventually, the tide will turn. When it does, a weaker dollar (again, compared with other major currencies) will likely be a big tailwind for U.S. stocks. It's one of the signs the trends of 2022 will be changing.

But we're not there yet.

Lastly, an update on the war in Eastern Europe...

Overnight, Russian President Vladimir Putin went on national television in Russia to announce plans to call 300,000 Russian reservists into the war in Ukraine. He also made what appeared to be a veiled threat to use Russia's nuclear weapons.

The move comes a few days before Russian-controlled regions in eastern and southern Ukraine are supposed to hold "referendums" on becoming parts of Russia, which Western leaders are already labeling as "frauds."

Put these two together, and you probably see the potential for escalation of the war. If Russia claims these territories, suddenly has more soldiers to defend them, and is threatening the use of nuclear weapons if the territories are attacked, what's next?

As CBS News reported...

Accusing the West of engaging in "nuclear blackmail," Putin claimed, without identifying anyone specifically, that there had been, "statements of some high-ranking representatives of the leading NATO states about the possibility of using nuclear weapons of mass destruction against Russia."

"To those who allow themselves such statements regarding Russia, I want to remind you that our country also has various means of destruction... And when the territorial integrity of our country is threatened, to protect Russia and our people, we will certainly use all the means at our disposal," Putin said. "It's not a bluff."

You can make of Putin's decision and rhetoric what you want. Some analysts have said it's a clear sign that Russia is losing its war. Others are not so sure, contending that bolstering Russia's depleted military simply means the conflict will drag on and escalate further.

A one-way ticket out of town...

Putin's speech also left many Russians thinking they could be drafted into battle. The results did not show a populace eager to sacrifice for Russia's Ukraine mission.

Scott passed along this note today, showing Google search activity at the time of Putin's speech in Russia for "Aviasales" – a Russian website for purchasing flights. One-way tickets are selling out in particular, Scott said...

Related searches for "where to leave Russia"... "visa-free countries for Russians"... and "mustache" (evidently for disguises to flee) also spiked in Russia at the same time, which was early morning in the eastern part of the country.

While the speech scared the daylights out of at least some everyday Russians, the global markets didn't react much – apparently because this move by Putin didn't come as a big surprise. And Russia's benchmark stock index was off by two-tenths of a percent.

This Is Three Times More Extreme Than 2008

"[The Fed] wants to tame inflation at any cost," says Genevieve Roch-Decter, founder and CEO of Grit Capital. And as she tells our editor-at-large Daniela Cambone, there will be consequences...

Click here to watch this interview right now. And to catch all our videos and podcasts from the Stansberry Research team, be sure to visit our Stansberry Investor platform anytime.

New 52-week highs (as of 9/20/22): Eve (EVEX).

In today's mailbag, feedback on yesterday's Digest about the possibility of an "earnings recession"... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"With a large percentage of the S&P having overseas exposure it seems logical that the strong dollar currency impact will have adverse impacts across the board. A lot of this will depend on how many of these companies engaged in currency hedging to brace for the impact on earnings.

"We started the year with the Russia invasion and China's Zero COVID policy further impacting the supply side of the inflation equation. The International Monetary Fund warned twice publicly that global GDP would take a substantial downturn, which was the first global recession warning. Last week the World Bank issued concerns over increasing rates.

"The central banks are viewing data which is difficult to control through rates with commodities, housing, wages, and healthcare...

"My concern is that these underlying CPI components may be quite stubborn to control... It will be interesting to see whether rate hikes will have an impact on these components. I foresee the rate hikes hurting corporate earnings more than these CPI components. For example, getting landlords to reduce rents would require fiscal policy intervention as would containing healthcare costs. Fiscal action and the will to implement such policy would take time.

"Since the central banks started their hawkish policy I've foreseen further recession on top of what the IMF had predicted. We went into a recession before rate hikes which will make it worse. There are some stubborn CPI components which I don't foresee responding.

"I hope that recession pains will signal the need to pivot on hawkish policy as I foresee a prolonged recession with stubborn segments of inflation. I've even suggested that central banks use new modeling for targeting specific segments with monetary policy as these sectors have unique behavior.

"We have global challenges with climate change which unite us all. I've been a proponent of keeping growth in the global economy intact to deal with this existential crisis. It's the great equalizer. Our diplomats have their work cut out for them with slowing down sovereign fears over resources driving their choices. We have new technologies which we can invest in which can address these fears to bring back global stability.

"It's time for humanity to 'pivot,' as everyone likes to say these days, to a collective agreement on what our global priorities are that we all share. In the interim, our institutions are leading our global economy into a deep recession with challenges for industry to invest in solutions." – Paid-up subscriber Rodger G.

All the best,

Corey McLaughlin
Baltimore, Maryland
September 21, 2022