Despite the Fed’s pullback to its first 0.50% interest rate hike in five months, markets responded negatively to the revised outlook from the Fed that rate hikes would continue into 2023 with the S&P closing down -0.61%, the Nasdaq down -0.76%, and the Dow closing down 1-42 points or -0.42%.
2022 was a year of extended market volatility, driven largely by the uncertainty around inflation and the Federal Reserve’s aggressive monetary policy. In the final rate hike of the year, it’s a trend that looks likely to carry into the new year as federal officials indicated that rates were likely to climb to between 5% and 5.5% next year.
Federal Reserve Chair Jerome Powell indicated in a news conference after the FOMC meeting that they would give serious consideration to slowing to the more traditional 0.25% increases as early as the next meeting that ends on February 1, which would equate to three more rate hikes in 2023 reported the WSJ.
The adjustment to fed fund rates expectations is up considerably from September’s Fed estimates that rates would be raised to 4.6% by the end of 2023. Fed officials are now expecting inflation to come down slower in 2023 than their September estimates in contrast to market expectations that have seen bond yields in the last month fall, potentially in hopes of a rapid decline in inflation.
“The problem is the more hawkish Powell sounds in the face of inflation on the downswing and rising recession risks, the more the yield curve inverts,” Donald Ellenberger, senior portfolio manager at Federated Hermes, told WSJ ahead of the Fed meeting. “Powell can push up short-term rates, but it’s getting increasingly difficult for him to push up long-term rates.”
Economic data that the Fed considers when hiking rates continues to offer up conflicting stories: on one hand broad inflation has slowed from its rapid gains earlier in the year, gaining 0.1% month-over-month in November to 7.1% year-over-year, and core inflation has slowed as well. Demand domestically is falling, and the housing market is dropping precipitously from peaks this year. On the flip side, the job market continues to remain resilient, despite slowing, and falling gas prices could boost spending by consumers in the coming months.
Investing for Fed Uncertainty in 2023
Beyond just higher end rates for fed funds rates, uncertainty remains for 2023 regarding how long the Fed will have to hold rates at their peaks next year to bring inflation closer in line with their desired 2% end goal. Given the volatility of 2022 that revolved around Fed policy, it’s not much of an extension to imagine much of that volatility will carry into 2023 while uncertainty persists.
Managed futures provided some outsized performance in 2022, a huge bonus on top of the non-correlated hedging opportunities the strategy can provide during times of increased volatility for portfolios. The KFA Mount Lucas Index Strategy ETF (KMLM) from KFAFunds, a KraneShares company, invests in futures contracts in commodities, currencies, and global bond markets and has had an outstanding performance this year.
KMLM’s benchmark is the KFA MLM Index, and the fund invests in commodity currency and global fixed income futures contracts. The underlying index uses a trend-following methodology and is a modified version of the MLM Index, which measures a portfolio containing currency, commodity, and global fixed income futures.
The index and KMLM offer possible hedges for equity, bond, and commodity risk and have demonstrated a negative correlation to both equities and bonds in bull and bear markets. Investing in managed futures offers diversification for portfolios and carrying them within a portfolio can potentially help mitigate losses during market volatility and sinking prices.
The index weights the three different futures contract types by their relative historical volatility, and within each type of futures contract, the underlying markets are equal dollar-weighted. Futures contracts will be rolled forward on a market-by-market basis as they near expiration.
Futures contracts in the index include 11 commodities, six currencies, and five global bond markets.
The index evaluates the trading signals of markets every day, rebalances on the first day of each month, invests in securities with maturities of up to 12 months, and expects to invest in ETFs to gain exposure to debt instruments.
KMLM carries an expense ratio of 0.92%.
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