#interestrates

Jerome Powell’s Jackson Hole Economic Symposium Speech

By:  Thomas Steffanci, PhD, Senior Portfolio Manager

The stock market (1) has reacted bullishly today to Federal Reserve Chairman Jerome Powell’s prepared remarks at the Federal Reserve Bank of Kansas City’s Economic Policy Symposium in Jackson Hole, WY. It was his first public admission of where he stood on tapering that pushed stocks higher: “At the FOMC’s recent July meeting, I was of the view, as were most participants, that if the economy evolved broadly as anticipated, it could be appropriate to start reducing the pace of asset purchases this year.” Despite Powell reiterating his Federal Open Market Committee (FOMC) meeting comments, the speech comes away as especially dovish,  in saying it would be wrong to respond to temporary fluctuations in inflation and his repeated statement that “the timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of an interest rate liftoff,”  added to the dovish tone.

It was a masterful performance from a Chairman whose FOMC committee members were split on the timing and speed of tapering. Without giving a specific timetable for tapering, he has bided his time to see more data on unemployment and inflation. He will get his first important data point in Thursday’s August payroll employment report.

  1. The S&P 500 is designed to be a leading indicator of U.S. equities and is commonly used as a proxy for the U.S. stock market.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s web site or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please see important disclosure information here.

The Bond Vigilantes Sing Don’t Cry for Me Argentina

By:  Steven L. Yamshon, Ph.D., Managing Principal

James Carville, President Clinton’s political consultant said at the time when Clinton was President, “I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.” 

Back in the early 1980’s, bond investors were a force to be reckoned with and these “bond vigilantes” took matters into their own hands when the government was fiscally irresponsible, selling bonds en masse, pushing up interest rates sharply higher and forcing the government to get serious. What is a bond vigilante and why does it matter? The truth is any bond investor is a potential member of this esteemed group. Investors who purchase fixed income products such as bonds want a positive real return on their investment. The real return is the return after inflation, and this is what counts, because it is what your money buys. Inflation erodes your purchasing power.

When the Great Financial Crisis occurred in 2008, the Federal Reserve (the “Fed”) had to use all the tools at their disposal to keep the economy from sliding into a depression. Lowering interest rates is just one tool at their disposal and the Fed lowered interest rates close to zero. To keep interest rates near zero, the Fed implemented a never-tried-before technique called Quantitative Easing (“QE”). Without getting too technical, this operation is called money printing and is equivalent to dropping money from helicopters. In 2008, the Fed had to do this to save the economy.  In 2020, the Fed did it again because of the COVID-19 pandemic but at greater speed and intensity. Most likely, this was an overkill, and we believe it will lead to a sustained level of higher trend inflation.

Where are the bond vigilantes? After all they have been in hibernation for a long time. There is one reason and one reason only. Inflation was low until now. However, the U.S. economy may be at a pivotal turning point. If history is any guide the bond vigilantes will most likely wake up in the next several years. In the 1930-1950 period, inflation spiked because of dollar devaluation during the 1930’s and to finance World War II (Chart 1). During this period the Federal Reserve accommodated fiscal spending by their massive power of the printing press.

Chart 1: Inflation (1930-2021)

When President Lyndon B. Johnson wanted to eliminate poverty and pay for the Vietnam War, known as “guns and butter,” he did so without raising taxes. This set off a stagflation period that lasted from 1969 to 1985 and only ended when Federal Reserve Chairman Paul Volcker raised interest rates to 20% (Chart 2). Volcker had no choice. He had to stamp out inflation and the bond vigilantes forced his hand.

Chart 2: Interest Rates (1970-2021)

By mid-decade, we believe the bond vigilantes will come out of their long-lasting sleep because the U.S. fiscal position will become unsustainable. The budget deficit, and trade balance of payments is exploding upwards. The major reason why the United States is not in the same situation as Buenos Aires, Argentina, is because the U.S. Dollar is the global reserve currency, but that exclusivity is eroding.

At some point investors here and abroad will say “enough is enough” and want increased compensation for the risk of holding U.S. government debt. That is when the bond vigilantes will awaken from the dead like the rise of the Phoenix and sing “Don’t Cry for Me Argentina”.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s web site or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please see important disclosure information here.

Monthly Economic Summary (June 2021)

Last month was an interesting month for the markets and below is the economic summary for June.  As always, if you have any questions or want to discuss more in-depth do not hesitate to give us a call!

Sources:

  1. Sources: J.P. Morgan Asset Management – Economic Update; Bureau of Economic Analysis (www.bea.gov); Bureau of Labor Statistics (www.bls.gov); Federal Open Market Committee (www.federalreserve.gov)
  2. Indices:
    • The Barclays Aggregate Bond Index is a broad-based index used as a proxy for the U.S. bond market. Total return quoted.
    • The S&P 500 is designed to be a leading indicator of U.S. equities and is commonly used as a proxy for the U.S. stock market. Price return quoted.
    • The MSCI ACWI ex-US Index captures large and mid-cap representation across 22 of 23 developed market countries (excluding the U.S.) and 27 emerging market countries.  The index covers approximately 85% of the global equity opportunity set outside the U.S. Price return quoted.
    • The MSCI Emerging Markets Index captures large and mid-cap segments in 26 emerging markets. Price return quoted (USD).

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s web site or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please see important disclosure information here.

The Inflation Dog Didn’t Hunt in April

CPI Treemap: Area Represents Weight in Index, Color Represents % Change Year-Over-Year (Source: Payden&Rygel)

By:  Thomas Steffanci, PhD, Benefit Financial Services Group

The past two weeks saw some eye-popping inflation readings. The consumer price index (CPI) for April came in at 4.2% year-over-year (YoY), but a surprisingly large 0.8% month-over-month (MoM) gain. The producer price index (PPI) was also hot, coming in at 6.2% YoY and 0.6% MoM.1

The Federal Reserve has been telling anyone who would listen for the past several months that transitory inflation outbursts were to be expected, caused by pent-up demand, relaxed Covid restrictions, the stimulus, and temporary supply constraints. These would not move the Fed to begin to withdraw their liquidity provisions to the economy, as employment was still far below its pre-pandemic level.  Several Fed speakers went on record with saying as much…and again after the inflation reports.

But to listen to Wall Street, these numbers will pull the Fed forward in their timetable to begin to withdraw their support by reducing their purchases of Treasury and mortgage securities. For years, Wall Street has had an imbedded ‘recency bias’, meaning giving the most importance to the most recent event. So, you would have thought that market prices of stocks and bond yields would have reacted to the these “shocking” readings by reacting negatively as horns blew and whistles sounded.

Well, that is not what has happened. The futures markets for bonds and Treasury bills barely fluttered. More importantly, stocks and bonds in the cash market reacted positively since the May 12 inflation news. Ten- and 30-year bond rates have fallen 10 basis points since then. And the Nasdaq gained 4.8%, and the S&P 500 has risen by 3.4%.2,3

So why did this happen? As always, the devil was in the details which are frequently ignored by the headline grabbing talking heads. Goldman Sachs in a recent report went behind the numbers to ferret out the details. Here’s what they found:  90% of the CPI increase was accounted for by reopening price rebounds and supply disruptions. By far the largest contributor to the price rise in that category was used car purchases as new car sales were disrupted by parts shortages. The other large contributor was transportation services, chiefly airline ticket sales. All the other categories (core services) barely budged. And add to this that the year-to-year comparison period was March 2020 where prices actually fell, so you have a distorted picture of the importance of the April CPI.

What do we take away from all this? Two things. The market saw through the fog of the headline inflation numbers so don’t listen to the noise of the moment. And second, all this tells us is that the market…maybe…just maybe…is starting to believe the Fed when they say they will continue asset purchases for “some time” and that liftoff for the Fed Funds rate will not start until the second half of 2023. Of course, several like-sized increases like April’s during the next six months could move the needle closer. But not now.

  1. Source: www.bls.gov
  2. The S&P 500 is designed to be a leading indicator of U.S. equities and is commonly used as a proxy for the U.S. stock market.
  3. Source: Morningstar.com

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s web site or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please see important disclosure information here.