Category: income

After a year of the Fed raising rates, bubbles deflating and inflation surging to levels last seen in the 1980s, economists and investors are girding themselves for 2023. The first signpost of where the economy is headed was the January Jobs report on 1/6/2023.

Will the employment market continue its strong run of reports? Is the economy slowing? Will the Fed be forced to continue hiking or, as markets hope, will they start cutting rates?

Expectations are for the Fed to continue hiking rates to a level above 5%; currently rates are 4.25%.

On August 26^th Fed Chair Jerome Powell addressed economists and decision-makers at the Fed’s annual Jackson Hole conference. His remarks had been anticipated for months. The inflation raging through the economy and repeated Fed rate hikes have deflated some of the bubbles we saw at the start of 2022.

The question is, will the Fed slow its rate hikes and allow the economy to have a “soft landing” or will the Fed keep raising rates potentially crashing the economy…

Powell left no doubt about the path forward.

Over the past few months several institutional investors have offered insights on how the markets were evolving given a laundry list of changing conditions, including rising inflation, a change in Fed policy to raise rates, energy prices, and slowing world growth…

In January 2022 Howard Marks of Oaktree Capital was interviewed on Bloomberg by Erik Schatzker. Marks gave his view of how market condition were changing at the start of 2022 and how investors could adjust. Schatzker asked Marks, “are you worried about inflation?” (1)

“I am worried. This is excessive. Everyone wants a little inflation. For years central banks have been trying to generate inflation and haven’t been able to do so. Excessive inflation is not desirable.

Higher inflation means higher interest rates and higher rates mean lower asset prices, and that’s what’s going on right now.”

In the last week of March 2022, the Federal Reserve revealed a regime change in their policy. The Fed moved from balancing jobs and inflation and being patient to a new policy of aggressively raising rates in order to fight inflation, regardless of its impact on the economy.

On March 16, 2022 the Fed raised rates for the first time in several years 25bps. The move was well broadcast and expected by markets for many months. Many critics of the Fed have complained the Fed has waited too long to raise rates. In 2020 the Fed lowered rates and engaged in massive quantitative easing (“QE”) in order to pull the economy out of the recession that resulted from the COVID shutdown.

On Monday March 20, 2022, Chair Powell appeared at the NABE (National Association for Business Economics) conference; his comments revealed a clear change in priorities at the Fed, and some insight to policy going forward. (1) In his statement he shares that “Supply chains are healing, but we are now seeing new COVID related supply disruption from China. The healing will come in time as the world settles into a new normal, but the timing and scope of that relief are highly uncertain. In the meantime, the Fed will be focused on trying to reduce price pressures.

As the magnitude and persistence of inflation became more clear at the end of 2021, the FOMC pivoted to less accommodative monetary policy. I believe these policy actions, and those to come, will help bring inflation down to 2% over the next 3 years.“

In the Fall of 2021, the economy continues to slow, and it is having an effect on markets.

I wrote this article originally just before COVID hit… some of the observations were in 2019, as you will see.

In 2019, the economy was already slowing…

It is interesting how the comments in the original article are appropriate for today’s economic environment.

In 2019, incoming ECB President Christine Lagarde stated the US trade war with China had “dented global economic growth.”

“You can’t adjust to the unknown. So, what do you do? You build buffers. You build savings. You wonder what comes next. That’s not propitious to economic development,” said Lagarde.

“It means less investment, less jobs, more unemployment, reduced growth. So of course, it has an impact,” she said. Lagarde led the International Monetary Fund for 8 years prior to moving on to the ECB. (1)

Recent surveys by the NFIB strike a similar note by US businesses that in 2021 are constrained by supply chain delays, increasing prices, and labor difficulties. (2)

Bonds are traditionally used within investment portfolios to reduce equity risk and generate income through the yields they carry. For example, a 10-year bond with a face value of $10,000 with a 5% yield generates $500 in income. Most recently the US 10-year yield was 1.5%.

However, over the past few years central banks in Europe and Japan have experimented with Quantitative Easing and driven rates below zero%. In August 2021, the amount of negative yielding bonds reached over $16.5 trillion. In May 2019 that amount stood at $12 trillion. Yields in Europe continue to fall as the ECB in June indicated its plans to set up a new bond buying program in upcoming meetings. A slow-down in the European economy, spiking energy prices and rising inflation has left businesses and economists frustrated. (1)(2)

What is a negative yielding bond? It is a bond with an inflated value and a yield of less than zero%. An example of a negative yielding bond is one with a face value of $10,000 but a market value $11,000. The purchaser of such a bond literally pays more than the bond worth for the right to own the bond. As bond yields move down the value of a bond increases. As bond yields move up the value of a bond decreases.

As energy prices and inflation has risen, bond yields have quickly moved higher. As a result, the amount of negative yielding debt has decreased, and the value of bonds held by central banks and institutional investors has plummeted.