What we've been seeing for the last couple of months is that markets continuously anticipate a Fed pivot. They're starting to come to terms with the idea that the Fed because they have to prioritize inflation over employment that actually there will be no capitulation in the near-term. 

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We're expecting inflation to come down very slowly mainly because central banks took so long before they started to actually raise interest rates. And by waiting so long, they've allowed inflation to permeate through the economy, move to the sticky items, such as shelter inflation, medical services, which once they get going it's very difficult to take out those price pressures. So the implication of this is that although headline inflation will be coming down, the focus will be in core inflation because core inflation could even rise further before it starts to come down. 

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We are expecting the Federal Reserve to have to raise rates further to 4.75% at least and then to hold them there. When we had the Federal Reserve summary of economic projections, they forecasted the unemployment rate hitting 4.4% at the end of 2023. So their forecast or even target of 4.4% unemployment rate really implies that the US economy is likely to hit recession next year and, not only that, but they accept the risk of recession. There will be no capitulation. There will be no pivot until they see inflation coming down meaningfully and sustainably for a fairly long period. 

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Coming into 2022, the US dollar was already overvalued. And yet it continued to appreciate because the Federal Reserve has been relatively more hawkish than other central banks. Other central banks, especially in emerging markets, have been more concerned about growth. So they haven't been willing to raise rates as much as the Fed. Unfortunately, as we've seen historically, when the US dollar hits these kinds of levels, it typically wreaks havoc across emerging markets and even developed markets. 

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There will inevitably be additional pockets of financial stress bubbling to the surface because the Federal Reserve and other central banks are hiking rates so aggressively. And combined with that, we have the strong dollar, and we have quantitative tightening. We have seen the Federal Reserve have to prioritize inflation over growth. That's why they're having to engineer a hard landing. 

However, once you start to see pockets of market dysfunction, the Federal Reserve's priority has to turn towards capital markets and making sure that there is no systemic financial failure. The Federal Reserve may end up having to follow the same path as the Bank of England and the European Central Bank raising interest rates to contain inflation but also buying bonds at the long end of the curve in order to contain financial stability concerns and prevent significant market dysfunction. 

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In this period, investors need to start thinking about being more defensive as they try to prepare for the volatile environment that lies ahead of us. Within fixed income, we like securitized debt. In this kind of economic environment, historically, securitized debt has outperformed other parts of the credit space. Within equities, we prefer mid-cap over both large and small cap. 

Not only do mid-caps have a more attractive valuation, but they also have greater domestic revenue exposure. And at a time when we expect in the US economy to outperform global economies, there are significantly more opportunities within the mid-cap space. Over the coming months, we are expecting inflation to remain high and for growth to be low. This is when real assets can really outperform. Not only do they provide a stable income stream, but they can also mitigate inflation pressures and portfolios. 

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