interest rates, risk management

“The Menace of Inflation”: Inflation in Perspective

In May 1974 Fed Chairman Arthur Burns gave a commencement speech to Illinois College. The speech was titled “The Menace of Inflation”.

At this point in the 1970s the nation had been struggling with high inflation for four long years… For perspective, we have been only dealing with high and rising inflation for one year so far. His voice offers a view of what to expect in the years to come.

“The gravity of our current inflationary problem can hardly be overestimated. Except for a brief period at the end of WW2, prices in the United States have of late been rising faster than in any other peacetime period of our history. If past experience is any guide, the future of our country is in jeopardy. No country that I know of has been able to maintain widespread economic prosperity once inflation got out of hand. And the unhappy consequences are by no means solely of an economic character. If long continued, inflation at anything like the present rate would threaten the very foundations of our society.” (1)

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economy, income, interest rates, retirement, risk management

Recession Risks Rise: a survey

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.”

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economy, interest rates, retirement, risk management

Housing Crisis 2.0

In 2008-2009 the nation was struck by a crisis in the mortgage credit markets that had repercussions for the next 15 years. The Great Financial Crisis (GFC) caused many people to lose their house or their job, or both. Many have yet to fully recover.

Fast forward to 2020-2022 and the housing situation in the United States is very different… Housing prices are rapidly rising and mortgage rates are headed higher as the Fed begins to raise rates and tighten financial conditions in an effort to fight inflation. Since WW2 housing has been a bastion of wealth building for the middle and working class. As an asset people were able to benefit from its appreciation and stability over time. Contrast this to the fact that many in the middle or working class have very little saved in their 401ks compared to the wealthier 10% of society; The wealthiest 10% own 89% of stocks, nearly $36 trillion. (1)

As housing prices and mortgage rates rise, younger buyers who are starting out in life are increasingly being priced out of the market. The University of Michigan Consumer Sentiment Survey takes a monthly snapshot of buying conditions for housing. The February 2022 figure came in at 36, a 42 year low. By way of comparison, the survey printed 70 in January 2020 and 56 in 2008 during the GFC.

So, the question is why are housing prices, as well as rents, continuing to rise with consumers largely sidelined?

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economy, income, interest rates, retirement, risk management

“The Fed is going to break things…”

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.“

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economy, interest rates, retirement, risk management

March Jobs Day – “There is a huge fog that is blanketing future economic outlooks.”

The geopolitical crisis of the past month has changed the global economic roadmap ahead. Russia’s invasion of Ukraine has disrupted flows of commodities and driven up prices stoking already high inflation. As a result…

Tom Keene points out “We are not focused on payrolls…” (1)

March 4, 2022 was the release of the jobs report for February. The estimate for new jobs is for 421k, and a 3.9% unemployment rate.

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economy, interest rates, retirement, risk management

Feb Jobs Day… “Buckle Up”

It has been a turbulent week…

Price of gasoline rose to the highest since 2014 at $3.43/gallon. Brent crude is at $93 per barrel.

Inflation number to be released next week is expected to rise to 7.3%, from 7.1% in January

On Thursday, the ECB announced it would pull back from QE faster than expected after their meeting on 2/3/22. ECB pivoted away from their policy of “lower rates for longer”. As a result, Italian yields are up dramatically. Yields of Italian bonds started the week at 1.2%… by Friday yields were over 1.7%. Negative yielding debt is at lowest level since 2018.

At a meeting in the UK, Bank of England Governor Bailey called on unions to hold off on demands for pay increases. Union officials called it “a sick joke”.

In equity markets Facebook (Meta) fell 25% and lost over $200billion in value overnight due to slower growth. The next day Amazon rose 15% and gained over $150billion in value on earnings and price hikes. These are massive flows of capital.

On Wednesday, ADP released numbers this week showed a decline of 301,000 jobs due to Omicron and a worsening in economic conditions due to rising bond yields. The question is how much of the drop is due to Omicron which is fading, and how much is due to a slowdown in the economy which could worsen as the Fed raises rates starting in March.

The White House warned “the January jobs number will be ugly”.

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economy, interest rates, retirement, risk management

What do rising rates mean for investors? In 2018, in 2020… and today in 2022

In January of 2022 markets sold off as investors came to grips with the realization that the Fed was committed to end Quantitative Easing (QE), raise rates by March of 2022, and begin selling assets from its balance sheet. After years of “easy money” monetary policy, the Fed had been forced to change direction due to rising inflation worries. (1)

“The market is significantly overvalued, which works okay when interest rates are at record lows,” said Mark Zandi, chief economist at Moody’s Analytics. “But when rates rise, valuations become a real issue, so the market is adjusting to the new interest rate reality.”

To understand how this affects your portfolio and retirement savings a bit of historical context can be helpful.

So first… a history lesson…

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economy, interest rates, retirement, risk management

Jobs Friday: December 2021

As a financial advisor and someone who loves the study of economics, “Jobs Friday” is the highlight of my month. It is a signpost of where the economy has been for the past month or two, as well as giving clues about where it is headed in the coming month. Information derived from the Jobs Report posted by the US Dept of Labor is used by the Federal Reserve to judge, manage, and adjust monetary policy. Politicians on both sides use the information to justify and drive fiscal policy.

For this month’s report the expectation was for the economy to have created 550,000 new jobs. One factor going into the jobs report that is a concern is ‘how many people are going to come back into the labor market?’ Currently, economists estimate that nearly 8 million people are still out of the labor force, having left at the beginning of the COVID pandemic in February 2020. (3)

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economy, income, interest rates, retirement, risk management

Economic Fears and Managing Risks

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)

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economy, income, interest rates, retirement, risk management

Negative Yielding Bonds and Risk

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.

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