#monetarypolicy

From the end of the Global Financial Crisis in 2009 until now, the combined balance sheets of the Fed, European Central Bank and the Bank of Japan grew from approximately $5.3 trillion to over $23.7 trillion.(1) The markets were awash in liquidity over the past decade, and the rising tide lifted virtually all financial assets. Central banks around the world are on track to hike rates more than 250 times this year while shrinking their balance sheets.(2) The FOMC post-meeting statement announced that balance sheet runoff will start on June 1. As Warren Buffett famously said, “Only when the tide goes out do you discover who’s been swimming naked.”

Here are 3 things you need to know (3):

1. The S&P 500 ended May with a gain of 0.01%, despite wild swings, a brief bear market (a drop of 20%), disappointing economic data, and pessimistic forecasts.
2. The April core PCE price index (the Federal Reserve’s preferred inflation measure) declined to 4.91% year-over-year. Core inflation was again boosted by rapid shelter inflation—which has run at the highest level since 1990 over the last year.
3. The FOMC raised the funds rate target range by 0.5pp to 0.75%-1.0%, as widely expected. The May FOMC minutes indicated a broad consensus for Fed Chairman Powell’s baseline of 50bp hikes at both the June and July meetings.

Sources:

1. Source: Blackstone Investment Strategy, national sources and Macrobond, as of 4/30/2022.
2. Source: BofA Global Investment Strategy, as of 5/5/2022.

3. 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)
4. 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 website 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 remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

Fed predictions, Omicron, geopolitical tensions, oh my! This year’s stock market weakness culminated with some of the sharpest intraday swings since the start of the pandemic. However, the stock market is forward looking, and investors may have already priced in this information.

Here are 3 things you need to know:

1. A sell-off among leading tech stocks contributed to a 9% decline for the Nasdaq composite, marking the index’s largest monthly decline since 2008. Over 75% of Nasdaq stocks were down 50% or more from their 52-week high at one point during the month.
2. The Federal Open Markets Committee (FOMC) left the funds rate target range unchanged at 0–0.25% but is preparing for a March rate hike and suggested it could front-load rate hikes even more than previously indicated. The Fed Funds Futures imply 5 full rate hikes this year.
3. The Russia-Ukraine crisis heated up as the U.S. and its NATO allies are bolstering troops in Eastern Europe and crafting harsh sanctions.

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 website 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 remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

By:  Thomas Steffanci, PhD, Senior Portfolio Manager

The markets are all aflutter as the Federal Reserve (the “Fed”) plans to reduce and then eliminate their purchases of government securities which are supposed to follow their first increase in the Fed Funds rate in March. That is estimated to be a 25-basis point (maybe 50-basis point) rise. If you believe the latest estimates of the members of the Federal Open Market Committee (FOMC), by the end of 2024 the rate would be up to 2 1/8%. And their “longer-term” estimate is 2 1/2%.

All this is in connection with the switch by the Fed from their pipe-dream estimates of last year that the burst of inflation was “transitory”. Now, apparently, it is judged to be not. So, they are going to tame inflation by raising the Federal funds rate to 2+% and at the same time reduce the size of their $9T balance sheet by not reinvesting the maturing bonds that they hold. 

In a Goldilocks scenario, this should take care of the inflation threat by year’s end. All the while, economists see 10-year bond yields reaching 2.5% – 3%. With inflation still likely lingering about 4%, where are the bond market vigilantes of old, that forced interest rates high enough to choke off inflation (and in the process caused the two recessions of 1980 and 1982)? With inflation likely two times the level of the estimated Fed Funds rate, what mechanism will tame the inflation?

Well, ironically, oil prices reaching $100/barrel are likely to be the new “vigilantes”. With oil production being penalized by Western governments via taxation or regulation to limit oil drilling, and at the same time global economic growth is expanding as the Covid pandemic becomes endemic, oil prices could continue to rise toward $100/bbl. While there is nothing magic about that price level, it can do two things: 1) keep overall inflation rising above expectations, and more importantly, 2) depress economic growth enough to take the word “recession” out of the closet. That’s all the Fed will need (especially in an election year and their history of overdoing it) to “blink” and reverse course, especially if markets continue to be under pressure and politicians need to be re-elected.  

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 website 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 remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

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

The Federal Reserve (the “Fed”) bank knows that there is too much liquidity in the system but has mixed feelings about reducing it. My sense is that the Fed will need to see that the following five factors are in place before they do anything:

• An unemployment rate in the neighborhood of 3.8%;
• Prime-age (25-54) labor force participation close to its pre-pandemic level;
• Accelerating wage growth;
• Long-dated inflation expectations at or above target levels; and
• Non-transitory inflation at or above target levels.

All of the above factors have been accelerating, which leads me to believe that the Federal Reserve will start to first taper excess liquidity, and then begin to raise interest rates by the end of 2022.

If the Fed liftoff occurs as planned and unforeseen circumstances do not occur, we expect the 10-year Treasury bond to level off around 2% to 2.25%. To us, the message is clear, in an environment of rising interest rates, new buyers of bonds need to keep their duration shorter than benchmark duration. If the Federal Open Market Committee (“FOMC”) follows through with increases in interest rates, monetary policy will not become extremely tight until 2024. It is too soon to guess about the pace of tapering and the rise in interest rates, but the big move in financial markets will likely occur when interest rates rise above the equilibrium rate. We are not there yet.

If monetary policy will not be restrictive for approximately three years, we believe it is too premature to shift to a defensive position, especially if investors share our view that risk assets should perform well over the next 12-months.

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.

By:  Thomas Steffanci, PhD, Senior Portfolio Manager

A series of margin calls and OPEC’s reiterating its ongoing 400,00 barrels/ per day increase in output lit a further surge in natural gas and oil today. Hedge funds and large traders have been making bets that natural gas prices in the U.S. would rise faster than in Europe. So, they shorted natural gas futures in Europe (via a futures exchange in the Netherlands) and were long U.S. natural gas. The explosion in European demand and tight supplies for natural gas over the past few weeks unleashed huge margin calls, forcing those dealers and hedge funds to come up with more cash forcing a covering of short positions to do so. Margin calls were a record shattering $30B. With OPEC+ sticking to its existing pricing strategy despite calls to increase output beyond that, Brent oil prices surged to $80/bbl., with West Texas Intermediate Crude (WTIC), topping $78 intraday. In a world where central banks tend to focus on core inflation (excluding food and energy) rather than headline inflation (including food and energy), will central banks look past the energy price shocks we are seeing?

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.