The Fed vs. Inflation
With October’s checkered history including both the 1929 market crash and 1987’s Black Monday, the 2022 rendition fared much better than its reputation as investors weighed their options amongst high inflation readings and the central bank’s plan to lower it. Not only did the Dow Jones Industrial Average have the best month out of the major US indices, but it was also its best month since 1976.
It was another month of investors showcasing their eagerness and hopeful optimism for the Fed to relax what have been aggressive rate hikes. So far this year, we’ve seen five rate hikes – three of which were 0.75% increases – to bring down demand and slow the economy to fight persistently high inflation.
The next Fed meeting is early November where another 0.75% increase is expected. However, investors are looking for any sign that the Fed can begin reducing future rate increases at the December meeting.
When the Fed announced rate hikes earlier this year to target inflation, one major concern was that the hikes could push the economy into a recession. This ongoing recession fear has provided a difficult backdrop for both equity and fixed income markets.
Our outlook has been predicting an economic slowdown for most of the year, allowing us to strategically and actively de-risk portfolios in conjunction to monitoring the progression of the macroeconomic landscape. In the meantime, our investment analysts are focused on building their shopping lists for when the environment shifts, when greater opportunities arise, and when we’re confident it’s time to begin buying.
Why is the Dollar ‘Strong’?
For most of the year, the US dollar has been gaining momentum as compared to foreign currencies like the Euro, British Pound, and Japanese Yen.
This comes during a year of high inflation, a worsening bear market and recession worries, so what’s influencing the dollar’s strength? It’s best explained using ‘The Dollar Smile’ theory, which states the value of the dollar will increase or decrease depending on the health of the economy, with the high points of the ‘smile’ occurring when the economy is either extremely strong or weak.
Not only can a strong dollar make international stocks a bargain opening the opportunity to diversify portfolios, but it can help consumers, too. Find out how in What A Strong Us Dollar Means.
New Trend: I Bonds
Series I bonds gained popularity in recent months as a security offering a rate of interest in-part based on the current rate of inflation. Although interest rate decreased from 9.62% to 6.48% on November 1st, I Bonds still offer attractive yield, but with some caveats.
The Treasury Department caps I Bond purchases at $15,000 per person, and like a certificate of deposit (CD), the purchase must go untouched for at least one year, and for five years to redeem at the full, current value.
This is potentially an attractive vehicle for individuals looking to boost their yield on additional savings with a tax-friendly option.
Since I Bonds are Federal bonds, they are completely exempt from state and local taxes (although Federal taxes will be paid on the interest gained during the duration of the bond). They offer the potential to produce higher interest rates than a low interest savings accounts for those who have cash on the side and a financial plan.
Read more about this trending security in I Bonds: What Are They and How Do They Work?
- Economic Cycle
- The economy is moving late cycle with speed; a recession in the US is becoming increasingly likely; the Fed is on a warpath against inflation, as it has found itself badly behind the curve and is being forced by high and persistent inflation to tighten into an already weakening economy
- Stock Market
- US stock market volatility continues; market weakness, coupled with relatively robust earnings growth, has improved valuations incrementally; however, equities remain expensive by longer-term historical standards; elevated valuations may be partly explained by robust corporate profitability, as EBIT margins have climbed to historical highs; rising input costs are posing a risk to the ability of corporations to maintain this elevated level of profitability; returns will be harder to come by and stock selection will be increasingly important
- Bond Market
- Interest rates have risen well off their lows reflecting shifting expectations on inflation, growth, and central bank policy; corporate and municipal bond credit spreads have widened, but not enough to make them materially more attractive at this time
- Issues on the Radar
- COVID-19: the worst of this economic crisis is behind us, and with multiple waves of the virus, including the Omicron variant, the attention is shifting to learning how to live with the virus; potentially impacting recovery, financial markets and currencies regionally
- Ukraine-Russia War: we believe an environment of elevated geopolitical risks over the coming months would entail a general risk-off environment; lending upward support to the dollar, gold, and commodity prices
- China’s Economy: China is an outlier regarding policy and has shifted to a gradual loosening stance while most of the developed world tightens aggressively; debt and property markets remain major issues; trade tensions continue to impact global trade and supply chains
- Inflation: a confluence of massive policy stimulus, tight labor markets, gummed-up supply chains, and rising energy costs are causing inflationary forces to broaden and become more entrenched than previously expected; conflict in Ukraine and lockdowns in China have added to price pressures
Sources: Wall Street Journal
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