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Key Points for the Week
“In the past week, Fed officials stepped up their rhetorical anti-inflation campaign, with Jerome Powell all but promising a half-point increase in the federal-funds target range at the next Federal Open Market Committee meeting, on May 3-4. And other Fed district presidents raised the possibility of more forceful action, including rate hikes of as much as three-quarters of a percentage point, something the Fed hasn’t done since 1994.”
The Fed’s goal is to slow high inflation, which has been exacerbated by the war in Ukraine and China’s coronavirus lockdowns, without pushing the American economy into a recession. The question is whether the economy is strong enough to continue to grow as the Fed tightens monetary policy. Economists’ opinions about that vary.
One participant in Barron’s Big Money Poll, which surveys institutional investors across the U.S., wrote: “It’s not as bad as people think…Yes, interest rates will rise, but earnings will also rise along with that. Profit margins continue to be very high, and employment is strong. It’s growth slowing down, not ending.
One participant in Barron’s Big Money Poll
Another participant disagreed, reported Nicholas Jasinski of Barron’s:
[The Fed] should have started the process of raising rates sooner so they could be more patient with the pace of increases…Now, they are going to be overly aggressive trying to play catch-up, and will probably go too far and slow demand down too much.
Nicholas Jasinski, Barron’s
Last week, major U.S. stock indices declined, reported William Watts and Barbara Kollmeyer of MarketWatch, and the real yield* for 10-year U.S. Treasuries was briefly in positive territory for the first time since the pandemic began in 2020, reported Jacob Sonenshine of Barron’s.
*When the term “real” is used with interest rates, it means the interest rate has been adjusted for inflation (the bond yield minus inflation). So, the real return is what investors would have after inflation.
Markets reflected the jittery disposition of investors. The rapid move in interest rates and persistent inflation have unnerved some investors and contributed to higher volatility. Volatility has risen in most asset classes, but bond investors have experienced the biggest swings. 2022 is tied with 1994 for the second largest decline in the last 29 years. And 2022 has more than seven months to go!
The latest volatility seemed to stem from a realization that the Fed is serious about raising rates by 0.5% rather than the normal 0.25%. Fed speakers have been telegraphing a 0.5% rate hike for several weeks. It appears the market reaction is reflecting concern future rate hikes may be even more rapid.
Inflation continues to be a problem outside the U.S. European inflation rose 2.4% last month. Russia’s invasion of Ukraine pushed energy prices higher and caused headline inflation to spike. Core inflation was still very high but rose 1.2% last month. Canada experienced similar trends, as energy prices contributed to a monthly increase of 1.4%. Canada’s central bank increased interest rates 0.5% to help combat elevated inflation. In Japan and Germany, producer prices are the biggest challenge, and they are likely to be partially passed on to consumers. The reelection of French President Emmanuel Macron should be a positive for markets as his opponent’s economic positions carried increased risk.
Stocks reacted negatively to the various releases last week, particularly Powell’s comments. The S&P 500 and global MSCI ACWI both dropped, and the Bloomberg U.S. Aggregate Bond Index declined as concerns about higher rates pushed bond prices lower. U.S. GDP leads a list of important economic releases this week.
2022 may end up being the most volatile year for bonds in many decades. The Bloomberg U.S. Aggregate Bond Index has fallen more than 0.5% a total of 16 times this year. The index of investment-grade U.S. bonds is down 9.5% so far this year. The more frequent declines in the bond market have made it most difficult for conservative investors. The S&P 500 has fallen 10% this year. Equity corrections aren’t so surprising, but a near correction in less volatile bonds is more surprising.
1994 and 2008 are the only competition for 2022 when analyzing bond volatility. The chart above was stretched back to 1994 because the Fed increased rates six times that year by a total of 2.5%. A final 0.5% increase in early 1995 was the last time the Fed raised rates by more than 0.25% in a single meeting. 2008 was volatile for different reasons as rates were cut rapidly. Investors were very concerned about corporate and mortgage defaults and bond prices frequently fell in response.
Inflation and interest rates are the source of the volatility in 2022. As nearly everyone is aware, prices for many goods have spiked in recent months. The Consumer Price Index (CPI) rose 8.5% in the last 12 months and is magnitudes above the Fed’s 2% target. Even core inflation, which excludes the effects of rapidly rising energy prices, has increased 6.5% in the last year.
In response to rapid inflation the Fed has indicated it will accelerate the rate of interest rate hikes. When rates move higher, borrowing becomes more expensive and some debt-financed projects are reduced or cancelled because of the higher costs. Those cancelled projects help to slow economic growth to levels the economy can sustain, reducing inflation.
The Fed is unwinding its rapid reduction of rates in 2020 in response to COVID-19. Rates were reduced by 0.5% on March 3 and by a full 1% on March 16 of that year. When faced with economic shocks the Fed often acts quickly to make borrowing less expensive and allow companies to stay in business. The Fed’s rapid response was generally viewed as successful in helping to reduce the economic damage from the pandemic.
While the Fed will take drastic action to cut rates, it generally unwinds those steps much more slowly by raising rates 0.25% at a time and typically every three months. In retrospect, the Fed should have started inching rates earlier than the 0.25% rate hike on March 17, 2022. Low rates and prolonged fiscal support contributed to a strong recovery while supply chain snags and people leaving the workforce reduced capacity. Higher inflation was the result.
This week’s selloff in bonds is a little perplexing because Powell’s indication that a 0.5% hike is likely was already reflected in expectations and had been widely signaled by Powell and other Fed officials. Jittery markets are prone to react, and the initial market reaction to Powell’s comments was to expect an even larger rate hike than he had suggested.
What happens next will largely depend on how sensitive the economy is to rate hikes. It will also be influenced by the pandemic and how countries trade off spikes in coronavirus cases with the loss of economic production. Some forecasters are expecting the Fed to raise rates extremely quickly and push the economy into recession. Our view is the Fed will take a more measured pace but raise rates by 0.5% the next two meetings to accelerate the move toward a more neutral posture.
For investors, this is a tough environment, and there is a tendency to treat bond declines like stocks, where the slides reflect potential risk of a major business failure. With bonds, that can be part of the risk, but the bigger risk in today’s environment is high inflation and competition against new bonds with similar maturities and higher yields. If new bonds maturing in seven years pay 3%, existing bonds maturing around the same time need to provide a similar return. If an existing bond pays less interest than newly issued bonds, then the price of the existing bonds must drop to provide a similar yield to the new bonds.
Because bonds mature, unlike stocks, there is also some good news in this move to higher rates. As bonds in your portfolio mature, whether held directly or in a fund, that money may be reinvested in new bonds that pay a higher yield. For some investors, the move toward higher rates may be good news as it signals the artificially low rates associated with the pandemic are over and bond portfolios may provide more yield compared to recent years. While painful in the short term, the move way from ultra-low rates may help investors with longer time horizons.
Consumer sentiment has been bouncing around, too. The preliminary results for the April University of Michigan Survey of Consumer Sentiment showed that sentiment jumped 10 percent from March to April, primarily because consumers are feeling more optimistic about the future.
However, the Consumer Sentiment Index is down 25 percent from April of last year. It’s a remarkable change when you consider what has happened in the economy over the last 12 months. For example:
It’s interesting to note that recent surveys have identified a disconnect between the strength of the economy and Americans’ beliefs about the economy. A February 2022 survey conducted by Navigator Research found that 35 percent of Americans thought the economy was experiencing greater job losses than usual. A February 2022 Gallup Poll found that 42 percent of those surveyed thought the economy was performing poorly.
Nobel Prize-winning economist Robert Shiller has written that strong narratives – true or false stories that catch on with the public – influence people’s thinking and decision-making around markets and the economy. The gap between Americans’ perceptions that the economy has performed poorly and is losing jobs and the reality, which is that we’ve experienced a period of strong jobs growth and economic expansion, provide food for thought.
The IRS is reminding taxpayers to be vigilant and watch out for IRS impersonation scams intended to trick them into providing their personal and financial information. Some of the schemes included text message, e-mail, and phone scams. The IRS also warns people to be aware of potential unemployment fraud.
Text Message Scams
If you receive an unsolicited text message claiming to be from the IRS or a program linked to the IRS, take a screenshot of the message and email it to firstname.lastname@example.org with the below information:
E-mail Phishing Scams
Please be aware that the IRS does not contact taxpayers by email to request personal or financial information. Most of the time, the IRS will contact taxpayers through regular mail delivered by the United States Postal Service. Similar to a potential text message scam, report the email to email@example.com by sending the suspicious email as an attachment.
The IRS (and its authorized private collection agencies) will never:
Organized crime rings have started using stolen identities to claim unemployment or other benefits for which the taxpayer never applied. Victims of unemployment identity theft may receive:
For information on necessary steps to take for suspected unemployment fraud, taxpayers can visit the U.S. Department of Labor’s fraud page here.
The IRS focuses on tax-related identity theft and suggested taxpayers take the below steps if they feel their Social Security number has been compromised:
If you have any questions about this information, please contact us.
April 29, 1929: Cleveland Becomes First MLB Team to Play with Numbers on Back of Jerseys
On April 29, 1929, the Cleveland Indians opened the season with numbers on the back of each player’s jersey, the first Major League Baseball team to do so. The numbers would make it easier for scorekeepers, broadcasters and fans to identify players.
The New York Yankees, who had won the World Series in 1927 and 1928, were supposed to debut jersey numbers the same day, but their opener was rained out. Thus, fans waited another day to see two of baseball’s greatest players, Babe Ruth and Lou Gehrig, to sport jersey numbers 3 and 4, which would become famous. Those numbers corresponded with the sluggers' spots in the batting order.
Cleveland, which changed its name to Guardians in 2021, experimented with numbers on the sleeves of jerseys for a few weeks in 1916.
In 1923, the St. Louis Cardinals also tried sleeve numbers, but found the practice had a negative impact on team morale. "Because of the continuing embarrassment to the players, the numbers were removed," manager Branch Rickey said.
By the 1937 season, every MLB team had numbers on the backs of jerseys. In 1960, the White Sox were the first team to put names on the back of their jerseys. The Yankees remain the only team without names on the back of jerseys.
We are all storytellers. We all live in a network of stories. There isn’t a stronger connection between people than storytelling.
Jimmy Neil Smith, Founder, International Storytelling Center
Don’t be afraid to give up the good to go for the great.
John D. Rockefeller, Business Magnate
Investment advisory services offered through SPC Financial® (SPC). *Tax services and analysis are provided by the related firm, Sella & Martinic (S&M), through a separate engagement letter with clients. SPC and S&M do not accept orders and/or instructions regarding your investment account by email, voicemail, fax or any alternative method. Transactional details do not supersede normal trade confirmations or statements.
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SPC does not provide tax or legal advice. Before making a legal, investment, or tax decision, contact the appropriate professional. Any tax information or advice contained in this message is confidential and subject to the Accountant/Client Privilege.
Portions of this newsletter were prepared by Carson Group Coaching. Carson Group Coaching is not affiliated with SPC or S&M. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. This information is not intended as a solicitation of an offer to buy, hold, or sell any security referred to herein. There is no assurance any of the trends mentioned will continue in the future.
Any expression of opinion is as of this date and is subject to change without notice. Opinions expressed are not intended as investment advice or to predict future performance. Economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful. Past performance does not guarantee future results. Investing involves risk, including loss of principal. Consult your financial professional before making any investment decision. Stock investing involves risk including loss of principal. Diversification and asset allocation do not ensure a profit or guarantee against loss. There is no assurance that any investment strategy will be successful.
The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The Dow Jones Industrial Average (DJIA), commonly known as "The Dow" is an index used to measure the daily stock price movements of 30 large, publicly owned U.S. companies. The NASDAQ composite is an unmanaged index of securities traded on the NASDAQ system.
The MSCI ACWI (All Country World Index) is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. As of June 2007, the MSCI ACWI consisted of 48 country indices comprising 23 developed and 25 emerging market country indices. Bond prices and yields are subject to change based upon market conditions and availability. If bonds are sold prior to maturity, you may receive more or less than your initial investment. There is an inverse relationship between interest rate movements and fixed income prices. Generally, when interest rates rise, fixed income prices fall and when interest rates fall, fixed income prices rise.
The Bloomberg Barclays US Aggregate Bond Index is a market capitalization-weighted index, meaning the securities in the index are weighted according to the market size of each bond type. Most U.S. traded investment grade bonds are represented.
Please note, direct investment in any index is not possible. Sector investments are companies engaged in business related to a specific sector. They are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification.
Third-party links are being provided for informational purposes only. SPC and S&M are not affiliated with and do not endorse, authorize, sponsor, verify or monitor any of the listed websites or their respective sponsors, and they are not responsible or liable for the content of any website, or the collection or use of information regarding any website's users and/or members. Links are believed to be accurate at time of dissemination, but we make no guarantee, expressed or implied, to the accuracy of the links subsequently.
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