Last week was the fall equinox, a time when the Earth’s rotation is directly perpendicular to the Sun-Earth line, tilting neither toward nor away from the sun. On the day of the equinox, daytime and nighttime are of approximately equal duration. One of the Federal Reserve’s primary objectives is to maintain stability of prices, or find an equilibrium where prices are stable and economic growth is not hampered. Conventional thought is that the Federal Funds Rate, needs to be equal, or close to equal, to the rate of inflation for prices to remain stable, but is that really the case?
The Fed has been widely criticized for not beginning to raise interest rates earlier, when inflation began to rear its ugly head back in 2021, which perhaps would have faster stymied inflation. And now some economists are criticizing the Fed for raising interest rates too quickly, stating the Fed is likely to “overshoot” the target, causing undue harm to the economy. This is predicated on the thought that inflation is likely to fall rather quickly since supply chain issues appear to be improving and energy prices are falling, neither of which the Fed has any control over. Many global economies seem to be headed for a recession, which tend to bring about higher levels of unemployment and lower levels of spending, leading to lower demand for goods and services and therefore lower inflation, if not deflation.
However, it is not interest rates that determine inflation, it is the amount of money in circulating in the economy. Leading back to the classic definition of inflation: too much money chasing too few goods. We have seen the supply of money explode since the pandemic, due primarily to stimulus payments and cheap borrowing costs. It will not be until the money supply shrinks that we will see substantially lower inflation. But in the meantime, the Fed seems determined to continue to raise interest rates with an increasing probability of causing a recession. Inflation will eventually ease because of higher interest rates leading to higher borrowing costs and therefore less money in circulation, as well as supply chain issues abating and the Fed further reducing its balance sheet. But working against this are high levels of government spending, which continue to add to the supply of money and cause sustained inflationary pressures.
The fall equinox also marks the calendar change in seasons from summer to autumn. But there has also been a change in market sentiment over the past several weeks. Back in July it seemed the Fed was going to be able to tame inflation by the end of this year and then pivot to start lowering rates in 2023, but now it has become evident that inflation is even more stubborn than earlier thought and the Fed will raise rates even more than previously expected. The 75-basis point (0.75%) interest rate hike by the Fed last week was not a surprise but the realization that the Fed is committed to remaining on a path of aggressive rate hikes sent stock markets reeling and pushed interest rates considerably higher, hitting levels not seen in over a decade across the yield curve.
Updated forecasts from the Fed (the infamous dot plots), which were released in conjunction with their meeting last week, now show a more aggressive path of rate hikes through 2023. The Federal Funds Rate is now forecast to end 2022 around 4.4%, a full percent above the June forecast of 3.4%. This suggests another 75-basis point rate hike in November and a 50-point hike in December, with a single 25-point hike in 2023, likely in the beginning of the year, before starting to ease policy in 2024. But given how much forecasts have changed recently, we would not bet the farm it happens in that exact manner.
With the latest events and more “hawkish” tone from the Fed, stock markets are not likely to quickly rebound. Bear market rallies, like what we experienced in July and the first half of August, are bound to occur from time to time. As a matter of fact, we would not be surprised to see a year-end rally after the elections this year. The stock market may have already hit the bottom, but it is not likely to eclipse previous highs until after the Fed has finished raising interest rates and economic growth rebounds. At this time growth seems to be slowing and will likely continue to while the Fed is raising interest rates. Since we expect rates to remain relatively high over at least the next couple of years, it very could be a somewhat prolonged period of challenges for the markets.
We want to remind investors to retain a long-term perspective of the market. Will stock markets be higher a year from now? Maybe, or maybe not. But we do have greater confidence they are likely to be higher 5 years from now as the economy adjusts to a new environment and again begins to expand. This is not a time to panic, but rather a time to be patient. And as we have been stressing over recent weeks, a good time to consider putting cash to work and perhaps adding non-traditional assets, besides stocks and bonds, for portfolio protection. There have been many bear markets throughout history and there are certain to be many more in the future. In the past, all bear markets eventually come to an end and the markets move higher. We do not expect this time to be any different. Guessing the precise timing of a market bottom and rebound can be a fool’s game so it is best to remain invested so to not miss out when it does occur. As always, if you would like to discuss your portfolio or have concerns over recent events, please do not hesitate to contact us.
We would like to extend an exclusive invitation to our next TaxSmart™ Summit on Thursday, October 13th with Becky Ruby Swansburg. Becky spent her early career working in Washington, D.C. with members of Congress and the White House under the second Bush administration. Her work on tax policy and America’s savings habits turned her attention to the urgent needs of today’s retirees. With her policy background and extensive retirement planning knowledge, Becky provides a wealth of information. If you want to learn ways to help protect and position your retirement assets for long-term success, no matter what future market and tax conditions may bring, you will not want to miss this event. Call us at 952-460-3290 to reserve your seat or click this link to register online.
Have a wonderful week!
Nathan Zeller, CFA, CFP®
Chief Investment Strategist
Please contact us if you would like to review your individual financial plan or learn how the TaxSmart™ Retirement Program can help you.
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