September Market Commentary: If the Fed Is Having a Goldilocks Moment, Is the Economy Baby Bear?

August Recap and September Outlook

After the bear market rally in July was extended for the first few weeks of August, Federal Reserve Chairman Powell used the Fed’s annual Jackson Hole symposium to clarify the Fed’s position on future rate increases.

Powell was clear that there would be no “Fed Pivot” until improvements in the inflation rate are sustained.

He acknowledged the costs of reducing inflation. Slower growth, higher interest rates for consumer loans, and a softer labor market are all part of the ongoing reality.

The Fed’s priority is to avoid entrenched consumer expectations of higher inflation, which partly caused the runaway inflation of the 1970s. The Fed needs to act decisively to bring inflation down quickly, which Powell described as a “forceful and rapid” approach to rate increases.

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Inflation, the Fed, and Recession. It’s Not Linear.

The June CPI number came in at 9.1%. This is not only the second consecutive month that we’ve seen an increase – it was a whopper. Consensus expectations were for an 8.8% annualized increase in inflation. This huge spike came after the Federal Reserve raised interest rates by a surprise 75 basis points after the June meeting and communicated that more – and higher – rate increases are in store.

As measured by the futures markets, the immediate response was to assume that the high inflation number would increase the likelihood of the Fed enacting at least a 75-basis point rate increase and potentially a 100-basis point increase at the FOMC meeting at the end of July.

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GMB #137: All About I-Bonds, TIPS, and Bond Investing in Inflationary Times

As inflation continues to rise, many questions have come up regarding best practices for safeguarding investments. This week on Grow Money Business, Grant takes a deep dive into bond investing in an inflationary market, and answers some important questions about Treasury Inflation-Protected Securities (TIPS) and I-bonds. Throughout the episode, Grant shares his thoughts on when they may be a good fit for your portfolio, as well as some important considerations and strategic approaches to bond investing.

 

 

Show Notes

[04:07] Bond Investing – Grant explains the process of bond investing and the importance of allocating a portion of your portfolio to US government securities.

[08:44] Treasury Inflation-Protected Securities – Grant discusses the similarities and distinctions between ordinary US government securities and treasury inflation-protected securities.

[13:41] Interest Rate Risk – Grant explains why the value of TIPS are decreasing even though they are intended to protect investors against inflation.

[21:26] I Bonds – Grant describes the structure of I-Bonds, and shares his thoughts on who is best suited to invest in them.

[25:48] $10,000 Limitation – Grant shares a strategic approach on how to circumvent the $10,000 per year per person investment limit that the Treasury Direct website imposes.

[29:00] Emergency Fund Cash – Grant explains why he does not recommend investing emergency fund cash in I-bonds.

[32:50] Borrowings – Grant describes how rising inflation affects borrowing and how to benefit from borrowing in inflationary times.

 

Resources

GMB #135: A Longer Look at Inflation & Monetary Policy With Kirk Chisholm

In recent months we’ve seen the highest inflation rates in the United States since the 1980s. As a result, many people seem to be concerned about the ripple effects of inflation and what the Federal Reserve is doing to handle it. This week on Grow Money Business, we’re joined by Kirk Chisholm, an expert in inflation, monetary policy, self-directed IRAs, and 401K. Kirk is also the wealth manager & principal of Innovative Advisory Group, which reshapes the wealth management industry via innovation. In this episode, Grant and Kirk dive deep into inflation and the current state of the markets.

 

 

Show Notes

[02:27] Background – Kirk describes his background and his journey thus far.

[05:54] Risk Management – Kirk provides a thorough overview of risk management from a portfolio perspective and how he applies it in his firm.

[15:59] Inflation – Kirk offers comprehensive perspectives on the current state of the markets.

[24:31] Deep-dive Into Inflation – Kirk and Grant dive deep into how rising interest rates will impact the United States economy

[48:22] Banking Systems – Kirk discusses the impact inflation has on banking systems, as well as his unique approach to investing money.

[01:00:40] Federal Reserve – Kirk shares his opinions on the Federal Reserve.

 

Resources

It’s Not About Inflation, It’s About Volatility

Inflation is driving the headlines and wreaking havoc on budgets. But for long-term investors – mostly everyone – short-term inflation isn’t the biggest risk to financial plans. Volatility is. It’s being fueled by the Federal Reserve’s efforts to balance bringing down inflation with keeping the economy out of recession.

The Fed is raising the key short-term interest rate to slow economic growth. This makes money more expensive, which you know first-hand if you have a credit card account or you’ve tried to buy a home or refinance an existing mortgage.

The reason this is generating volatility is that markets hate uncertainty. Markets are forward-looking and attempt to price into stocks and bonds today, things that will likely happen in the future. The issue is that the Federal Reserve can’t tell the markets in advance exactly how much and when they will raise interest rates because it’s a delicate task depending on a lot of ever-changing economic data. And let’s be honest, probably some guesswork.

Fed Chairman Powell, and the Fed governors, have been examples of message discipline. They’ve been doing everything they can to reassure markets. But while markets may be rational, investors aren’t.

So, as an investor, how do you cope with volatility? We have some pointers.

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Are Fed Actions Working? Parsing the New Data

After April’s downturn, the first two weeks of May have not seen substantial improvement. By Thursday, May 12, markets were dangerously close to bear territory. The Fed enacted a 50-basis point increase in the Fed funds rate at the May FOMC meeting, and we also now have April’s key data. In addition, Fed Chairman Powell sat for an interview in which he discussed his definition of a “soft landing” and what it will take to get there.

Our three main points are the labor markets, interest rate hikes, and economic growth as measured by GDP. Let’s dive in.

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May Market Commentary: The Fed Owned It, But Can They Control It?

April Recap and May Outlook

COVID concerns took a definitive backseat as mask mandates on flights ended, and the concerns about the economy turned to how bad things will get. The concerns over the disruption of the ongoing war in Ukraine, 40+ year record inflation, and the resulting amping up of the Fed’s intentions on rate increases moved distinctly into the foreground. Let’s look at some headlines:

  • The IMF released projections for the impact of the war in Ukraine. Global growth will likely slow from an estimated 6.1% in 2021 to 3.6% in 2022 and 2023. This is 0.8 and 0.2 percentage points lower for 2022 and 2023 than projected in January.

  • The war isn’t just impacting growth. The IMF also reported that war-induced commodity price increases and broadening price pressures have led to 2022 inflation projections of 5.7% in advanced economies and 8.7% in emerging market and developing economies—1.8 and 2.8 percentage points higher than projected last January.

  • In remarks at a panel discussion at the IMF on April 21st, Chairman Powell reiterated that it is appropriate “to be moving a little more quickly” on rate hikes. That translated into guidance on the first 50-bps rate increase in 22 years.

  • Economists began talking about “stagflation.” Stagflation is high inflation, high unemployment, and slow or negative real economic growth. Stagflation fears rise out of the potential for the Fed to overshoot and tip the economy into recession. Another way to think of stagflation is a circular firing squad. In stagflation, the moves the central bank makes to rescue the economy push it further into recession.

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What’s Driving the Recent Volatility? A Quick Guide

The Federal Reserve has been very clear about its intentions to move more aggressively in fighting inflation. It currently defines “more aggressively” as a likely series of 50 basis point rate hikes, beginning with the May Federal Open Market Committee meeting. This will mark the first time in 22 years that the Fed has doubled the normal 25 basis point increase.

In remarks at a panel discussion at the IMF on April 21st, Chairman Powell reiterated that it is appropriate “to be moving a little more quickly” on rate hikes. He also indicated that he believes that financial markets are “acting appropriately generally,” meaning that they are adjusting to the expectations of higher rates.

Markets are forward-looking, so prices today reflect what markets think will happen in the future. A good example of this is mortgage rates: The average rate on a 30-year fixed-rate mortgage was 5.29% as the last week of April opened. For contrast, in early March, it was 3.76%.

Markets are having trouble interpreting this information. The problem is that so far, we’ve heard the Fed’s intentions, but without corresponding data showing whether or not rate hikes are working, markets can’t assess the likely path. And that leads to volatility.

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What’s the Fed Up To? Rates, Inversions, and Quantitative Tightening

The U.S. Treasury yield curve inverted last week. An inversion is when the shorter-term yield in a pair of U.S. Treasury maturities is higher than the longer-term yield, reversing or inverting the normal relationship. The significance of a yield curve inversion is that inversions have a history of predicting recessions.

The yield curve inverts because investors believe that the economy will slow in the future. The Fed attempts to control inflation by increasing interest rates, which makes business investment more expensive. Markets appear to think that the Fed will overshoot with rate increases, which will stifle rather than slow economic growth. The Fed will then have to begin decreasing rates again.

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The Federal Reserve vs. Inflation: Round One

Wednesday’s long-anticipated announcement by the Federal Reserve that the key Fed funds rate would increase by 25 basis points and the accompanying statement by Chairman Powell had the immediate impact of reassuring the markets. St. Patrick’s Day may not have brought pots of gold, but after thirteen no-good, very bad weeks for the S&P 500, we’ll take a push back into positive territory.

Will it last? Given the invasion of Ukraine, the impact of sanctions, the downstream effect on supply chains and food supply, and the geopolitical uncertainty unleashed by Russia’s aggression, the Fed’s job in fighting domestic inflation is much harder now.

We walk through the Fed’s move and Powell’s language, the impact of the rate increase, and what investors can do to prepare their portfolios and budgets.

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