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Inflation, unemployment, and the Fed

The U.S. Federal Reserve has a dual mandate: to ensure price stability and aim for maximum employment.

The first task has been a challenge: prices have been anything but stable. In June, U.S. consumer price index saw its biggest 12-month increase in 40 years. While the headline CPI number has cooled off from its peak recently — September’s inflation rate was 8.2% year-over-year — it’s still worryingly high.

The labor market — the Fed’s second task — seems to be in much better shape. In September, the unemployment rate fell to 3.5%, a multidecade low.

Given this labor market strength and rampant inflation, the Fed is raising interest rates aggressively to bring price levels under control. The central bank increased its benchmark interest rates by 75 basis points last month, marking the third such hike in a row.

Gapen expects the Fed to remain hawkish.

“They’ll accept some weakness in labor markets in order to bring inflation down,” he says, adding that “we could see six months of weakness in the labor market.”

According to the Fed’s latest projection, Federal Open Market Committee participants have a median forecast of 4.4% for the unemployment rate in 2023.

Gapen, on the other hand, sees the unemployment rate in the country rise to 5% or 5.5% next year.

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More downside for stocks?

The prospect of negative job growth and a recession probably won’t bode well for the stock market. When the economy contracts, corporate profits usually deteriorate.

In fact, stocks have already been pummeled — the S&P 500 has plunged 25% year to date.

Bank of America’s head of U.S. equity and quantitative strategy Savita Subramanian recently said that the benchmark index is “expensive” and “super crowded.”

“The worst thing to hold is the S&P 500 wholesale,” she tells CNBC.

Subramanian suggests that if you have a 10-year investment horizon, you can “hold the S&P 500 and watch and wait.”

“But if you're thinking about what's going to happen between now and let's say the next 12 months, I don't think the bottom is in.”

What should investors do?

Subramanian sees opportunities in small-cap stocks, energy, and healthcare. She also likes “select industrials” — particularly automation plays.

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About the Author

Jing Pan

Jing Pan

Investment Reporter

Jing is an investment reporter for MoneyWise. He is an avid advocate of investing for passive income. Despite the ups and downs he’s been through with the markets, Jing believes that you can generate a steadily increasing income stream by investing in high quality companies.

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