How much longer can Fed keep hiking before risking recession, Hirtle Callaghan CIO asks

The most important question for institutional investors now is how long the Federal Reserve will keep hiking its policy rate to bring inflation back down to its 2% target. That's the view of Mark Hamilton, the Conshohocken, Pa.-based CIO at Hirtle Callaghan & Co.

"Inflation has fallen significantly from the highs of last year as the impact of COVID-19-related disruptions to supply chains and the energy shock from Russia's invasion of Ukraine have abated," he said by email. "Now the key question is whether wage increases fall back to a level consistent with 2% inflation or not, and whether we have to endure a recession to get there."

Mr. Hamilton worries that if inflation remains elevated it is "certainly possible" that tight Fed policy could "trigger a recession."

"There are signs of weakness in housing and manufacturing, but broader indicators of current GDP growth and the labor market do not indicate we are in a recession yet," he added.

Moreover, low unemployment figures are also "complicating" the Fed's objective to bring inflation down to its target. "For now, strength in the labor market and increasing wages will likely mean more Fed hikes, albeit at a slower pace than last year as they see whether underlying inflation continues to decline," he added.

Within equity markets, Mr. Hamilton said he favors U.S. equities versus other developed markets such as Europe "given their lower cyclicality and less direct exposure to the ongoing war in Ukraine." In general, he has a "modest preference" for quality stocks over cyclicals for the "protection they likely offer in the event of a downturn."

Within fixed income, Mr. Hamilton likes Treasury Inflation-Protected Securities, or TIPS, for their "attractive real yields and protection against further inflation." He also thinks there are "good opportunities" in private credit, especially where there are "higher yields and better covenants than in the public credit market."

Mr. Hamilton also noticed something interesting about the markets that institutional investors should be aware of — the equity and bond markets are pricing in very different outlooks for the economy.

At current multiples, he said, equities appear to be pricing in "a growth outlook in which inflation declines, earnings remain resilient, and lower interest rates support above-average multiples."

In contrast, the bond market "appears prepared for more Fed rate hikes over the near term followed by a possible recession which will bring interest rates back down."

If the latter view is correct, he warned, "we will see more volatility than the market seems to expect."

Hirtle Callaghan, whose client base is split between institutions and high net worth families, has about $17.6 billion in assets under management.