Alright, so what is going on with the Federal Reserve, why does it matter, and how is it going to impact you?

In case you didn’t know…. 

The Federal Reserve is the central bank of the United States – it was founded by Congress in 1913 in large part as a response to the Panic of 1907,which was the first worldwide financial crisis of the 20th century. As such, the Fed is tasked with, and I quote, to “provide the nation with a safer, more flexible, and more stable monetary and financial system.” 

Central to the Feds authority and it’s primary tool to conduct monetary policy is its ability to affect how much banks charge each other for lending money on an overnight basis, which is known as the federal funds rate. This rate is extremely important & closely tracked as it impacts everything from how much you and I pay in interest on our credit cards and our auto loan rates to how much we earn with our money on deposit at the bank.

Back in March of 2020, which seems like an eternity ago, the Fed slashed interest rates to near zero as COVID-19, or the fear and uncertainty of COVID-19, was upending the global economy sending us here in the U.S. into a short lived recession.

Since then, the stock market has been on an absolute tear. In fact, from its trough in March of 2020 to it’s all time high on January 3rd, the S&P 500 had climbed back 114%. In fact, according to Federal Reserve data, the value of financial assets held by American Households was almost 32% higher, or $27.5 trillion, than in the first quarter of 2020 – a staggering amount of wealth.

However, as we’ve watched the first month of the new year play out, markets were on a downward spiral leading up to the latest guidance on interest rates from the Federal Reserve on Wednesday, January 26th, at the conclusion of their two-day policy meeting.

All eyes were on Federal Reserve Chairman Jerome Powell, as he signaled that the Fed would begin steadily raising interest rates in mid-March, halt asset purchases, and begin to significantly reduce bond holdings on its balance sheet in its latest attempts to peel back stimulus & calm down soaring inflation. Which, in December, had jumped 5.8% from the year prior, using the Fed’s preferred price index, the Personal Consumption Expenditures Price Index. The likely raise in March would be the first increase in interest rates since 2018.

The Fed is currently walking this tightrope in wanting to not raise rates too aggressively and throw us into another recession, but to also get inflation back in line with its 2% target and keep up a strong labor market.

During his press conference on the 26th, Chairman Powell said, “There’s a risk that the high inflation we are seeing will be prolonged. There’s a risk that it will move even higher.” He continued, “…We have to be in a position with our monetary policy to address all of the plausible outcomes.”

On January 12th, the Labor Department shared that the Consumer Price Index – which measures what consumers like you and I pay for goods & services – rose 7% in December from the year prior which was the fastest increase since 1982. 

Now inflation back in the 80s was very different from what we are seeing today. You see, instead of inflation rising, it was actually coming down from a high of 14.8% in April of 1980 while Jimmy Carter was still sitting in the oval office. 

In 1979, Carter appointed the legendary Paul Volcker to become Chairman of the Federal Reserve at which he immediately set out to tame inflation with tight monetary policy. 14 months later, Ronald Regan would make his home at 1600 Pennsylvania Avenue and in the summer of 1982, thanks to Volcker’s actions, inflation had all but retreated to a much more palatable level.

Now back to the present day, for most of us, inflation has impacted several areas of our day-to-day lives. An article put out by the Wall Street Journal recently provided inflation figures for 2021, so let’s take a look at some numbers.

1. Used auto prices rose by a staggering rate of 37.3% in December with new vehicle prices climbing 11.8%. 
   
2. Gasoline prices in November saw an increase of 58.1% from a year earlier – the sharpest since 1980 which we just discussed, along with December seeing a 49.6% increase from the year prior.
   
3. Prices for furniture & outdoor recreation also trended upward with prices for living room, kitchen, and dining room furniture increasing 14.1% in November from a year prior, and outdoor equipment & supplies going up 7.8% in December 2021 from a year prior.
   
4. Travel was an interesting one that was impacted by inflation, of course during the height of COVID-19 in 2020, airline fees & hotel prices plunged as no one was going out. Hotels finished 2021 up 11.1% from the year prior but with the new variants & restrictions placed on international travel, airline fees were actually down 17.9% in December from the year prior.
   
5. As more and more people begin going back to restaurants, prices for meals began to climb sharply with fast food spots seeing an 8% increase and sit down spots seeing a 6.6% increase. 
   
6. Grocery prices also cut into our bottom line as store-bought food increased by its fastest pace since 2008. Beef & veal were up 18.6%, pork 15.1%, and overall groceries up 6.5%.
   
7. Rent for housing also increased by 3.3% with the owners equivalent, which is an estimate of what owners would have to pay if they were renting their own home, jumped 3.8%.
   

So now that we know where we are in regards to the impact of inflation and have the Fed’s most recent guidance on the future of interest rates, the issue we are now grappling with is just how much will the increase in rates be. Will we see the typical quarter-point move or potentially a more aggressive stance?

In an interview with the Financial Times, Atlanta Fed President, Raphael Bostic, stated, “If the data says that things have evolved in a way that a 50 basis point move is required or appropriate, then I’m going to lean into that”. The Fed last raised interest rates by 50 basis points, or half a percentage point, in May of 2000 under then-Chairman Alan Greenspan.

When asked about a 50 basis point increase, Chairman Powell responded with, “We fully appreciate that this is a different situation. We really have not addressed those questions, and we’ll begin to address them as we move into the March meeting and meetings after that.”

So Powell certainly did not give us much to go on, but we do know that the bar is very high for a 50 basis point increase in March, which would certainly be a shock & awe announcement from the Fed.

What’s interesting is that because Powell did not specifically reject the idea of a 50 basis point increase, Wall Street has since taken a more aggressive approach in pricing monetary policy than just a few weeks ago.

Economists, analysts, and everyone in between have been all over the place with their predictions on just exactly where rates will land by year’s end. Some expect 3-5 hikes with the target rate landing between 1.25% to 1.50%, while others, like the economists at Bank of America, forecast 7 quarter point increases putting the target range between 2.75% to 3%. 

No one knows for certain what the future holds, and as we know, anything can happen. 

Of course the rise of Omicron cases and continued supply chain issues, could have the Fed pump the brakes a tad bit as consumers stay at home, not go to work, or spend any money. This hopefully will be short lived.

What we do know, however, is that the stock market does not like uncertainty, and that is exactly what it’s been fed over the past two years with no shortage of helpings in sight. As extremely accommodative and loose monetary policy has boosted the economy and given way to high asset prices, many investors have now grown weary with how aggressive the Fed will be, and if inflation will continue to rear its ugly head. 

As it pertains to inflation & your investments, according to the US Bank Asset Management Group, there has been a positive correlation between inflation and stocks of large companies over the past three decades. In other words, rising prices help bolster the balance sheets of many public companies which in turn yield higher returns for investors who own their stock. 

With regard to interest rate increases and your investments, historically when rates increase it’s good for stocks overall. This of course with the understanding that rates are increasing because the economy is growing at a good pace, not decreasing.

According to Dow Jones, using data going back to 1989, during a Fed Rate hike period – which we look to be entering into in March – the average return for the Dow Jones Industrial Average is 55%, the S&P 500 at 62.9%, and the NASDAQ at 102.7%. Now an important thing to note about these huge returns is that the averages include the period between 2008 & 2019 which saw triple digit returns for these respective indices. 

The markets have another historical precedent on their side this year as since 1950, the S&P 500 has been positive 85% of the time the year after a return of 25% or more with an average return of 11.6%. Interestingly enough, one of the two negative years was back in 1980, the year in which we discussed earlier and which inflation hit just under 15% before coming back down. 

So, what are some things you can do prior to the Fed’s next meeting in March as we are likely to see more volatility in the markets? 

Run a portfolio stress test.

The best way to cure an illness is to get out in front of it, and the same goes with your investment portfolio.

Are you taking too much risk at this point in your life, or perhaps not enough? Something we share with our clients is, “Look, you’re already rich, how do we help you stay rich?” The rules of the game change in retirement, in other words, what got you to the point where your money is now working for you, most likely is not the same blueprint to follow in sustaining that throughout the rest of your lifetime. Let’s run a complimentary portfolio stress test and figure out not only where you are but potentially where you should be. 

Stay calm—corrections and pull backs are normal.

Easier said than done, yes, but again, history has shown us those that stay put are rewarded. 

Howard Marks in his latest memo, Selling Out, says, “Reducing market exposure through ill-conceived selling – and thus failing to participate fully in the market’s positive long term trend – is a cardinal sin in investing. That’s even more true of selling without reason things that have fallen, turning negative fluctuations into permanent losses and missing out on the miracle of long-term compounding.”

Okay, enough on interest rates for today. We will be monitoring this in the days to come so that you can get back to whatever is you love doing, continue to make a huge impact, and build a legacy that lasts for generations.

Connor Parker
Parker Financial Group

P.S. – to schedule an appointment with me, click here.

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