Portfolio Return as of 08/12/22:
2020: 25.65%
2021: 29.15%
YTD: 6.2%

Thursday, March 3, 2022

What Will the Fed Do? Will It Be Enough?

Fed chair Jerome Powell was appeared before Congress yesterday to give his semi-annual monetary policy report. In no uncertain terms, he backed a rate hike at the Fed's upcoming meeting on March 15-16. Specifically, Powell said he was "inclined to propose and support a 25 basis-point rate hike"-- the kind of plain-speak you rarely hear from Fed chairs, ever, about future tightening plans.

Goldman Sachs reiterated their call for seven hikes -- one per meeting -- this year soon after Powell's remarks. The market isn't fully pricing that in yet. Of course everybody is extremely nervous about how poorly events could play out in Ukraine, or even closer to home, based on Russia's continued military action. But as Powell himself noted, we have no idea how those events will play out. What we do know is the impact they already having -- an impact that is undoing the Fed's efforts to tighten and lessen inflationary pressures in the U.S. economy.

How so? 

(1) Interest rates have fallen, from 2.05% on the 10-year Treasury in mid-February to as low as low as 1.68% this week. We're back around 1.87% this morning. The problem with that is inflation hasn't slowed, nor has the economy. (Jobless claims this morning were extremely low.) In other words, rates are too low and are acting to stimulate an already overstimulated economy at the very time that the Fed is trying to remove said stimulus. Mortgage rates, which the Fed is trying to raise, have now actually fallen even as home prices just set another record high.

(2) Inflation expectations have actually risen. In the same time period, since mid-February (prior to the Ukraine invasion), the market's expected inflation rate over five years has surged from 2.9% to nearly 3.25% yesterday. That's nearly a point higher than the highest readings we saw in the decade following the financial crisis. The spike in oil prices--the U.S. benchmark hit a fresh cycle high of $116 this morning--isn't helping. This means "real yields," which I mentioned above, are down even more relative to higher expected inflation rates.

(3) The economy isn't stalling, and leading indicators are still strong. Weekly new jobless claims totaled just 215,000 this morning, and the four-week average of continuing claims hit its lowest level since 1970. The monthly jobs reports have been surprisingly strong. Durable goods orders just came in much stronger than expected for January. Same for retail sales. 

Just be prepared for some volatility in the market and have an exit plan if that should become necessary. Otherwise, stick to your investment plan

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