Investors closely monitoring the Federal Reserve this week should remain vigilant as inflation will continue to hit their assets. An expected half-point or three-quarter-point rise in interest rates could result in significant market moves.

The Federal Open Market Committee (FOMC) meets on Tuesday and Wednesday. Inflation is at a 40-year high and has continued to rise despite the Fed’s best efforts.

The consumer price index is at 8.2%, a level last seen in January 1982. Continued pressure from supply chain disruptions, the Russian invasion of Ukraine, and US consumer borrowing and spending at near-record levels have made it difficult for the Federal Reserve to contain inflation. I expect the Fed to hike rates by 50 to 75 basis points during their November meeting.

Importantly, inflation is an even bigger challenge for the Federal Reserve because inflation is global; Major central banks such as the Bank of England, the European Central Bank and the Bank of Canada have also raised interest rates with little success. Inflation in the UK and the Eurozone is over 10% and in Canada is close to 7%.

While analysts at Morningstar and JPMorgan have announced that they expect inflationary pressures to ease in 2023, investors should remain vigilant about how inflation will continue to affect their investments. The reason that inflation is expected to fall next year is that a recession is imminent in many countries. The current inflation will cause both consumers and businesses to reduce spending, which will unfortunately lead to a fall in gross domestic product (GDP). If there is a significant recession, this will also push down corporate share prices.

Inflationary pressures are not only hurting consumers, they are also driving up corporate borrowing costs. In the face of higher borrowing costs, companies then continue to raise prices for consumers. Also, I expect companies will start reducing the dividends they pay investors. Unfortunately, this is a bad spiral for the foreseeable future and I anticipate significant bouts of stock market volatility.

As long as the Federal Reserve cannot control inflation, I expect investors will continue to regularly sell equities and flock to US Treasuries and investment grade bonds as safe havens. The stocks that will be particularly affected are those of companies that are heavily leveraged, which bank regulators typically describe as owing six times their earnings before interest, taxes, depreciation and amortization (EBITDA). Unless the Fed can control inflation, leveraged companies will find it increasingly difficult to pay their existing debt, and if they can get lenders to lend them more, the interest rate the companies will have to pay will be higher.

Everywhere I look, there is ample data and market signals that the leveraged loan and high yield (below investment grade) markets are increasingly troubled. Fitch Ratings’ monthly US Leveraged Loan Default Insight study, released last week, shows that the dollar volume of total leveraged loans rose 13% from top market concern to $228.0 billion from $201.3 billion in September is; This is the largest one-month increase since the outbreak of the pandemic. Fitch Ratings’ list of other issuers at risk shows “an overwhelming majority of new entrants, driven by technology at 41% of new entrants, healthcare/pharma at 23%, construction/materials at 17% and banking/finance at 9%. Citrix systemsCTXS
Inc., Quest Software Inc. and Ivanti Software are significant technology issuers included in the Other Markets At Risk list. The total number of market worries is up 39% since the end of Q1 22 and is the highest amount since YE 2020.

According to Eric Rosenthal, senior director of leveraged finance at Fitch Ratings, “the more worrying top market concern total jumped to $34.0 billion from $29.6 billion in September. Bausch healthcare companyBHC
Inc., which completed a distressed debt swap for just 48% of its unsecured debt obligations, is a new addition to the top list as a 2023 filing remains a possibility. Almost 30% of top list issuers have a term loan, 19% by volume, maturing before YE 2023, led by Serta Simmons Bedding LLC. ColourOz MidCo’s and infoGROUP Inc. moved up from Tier 2 in October due to their upcoming maturities.” The clear majority of leveraged loans and high yield bonds are in the BB and B range. The expectation of more companies being downgraded or, in the worst case, defaulting on their commitments, will have investors poised to sell bonds and stocks in the near term.