- Scott Poore, AIF, AWMA, APMA
You Can't Always Get What You Want
I highly doubt the Rolling Stones had monetary policy in mind when they wrote their hit song, but the title is appropriate when it comes to the Fed and the markets. The market wants to have their cake and eat it, too. Yet, the Fed is trying to navigate the waters of market expectations and higher inflation. There have been multiple Fed speakers this week as Fed governors are trying to ease investor concerns. The conclusions presented by Fed governors has been mixed this week, which makes Mick Jagger's lyrics all the more telling when he sang, "But if you try sometimes, well, you might find, you get what you need." If you're in the camp that wants the Fed to keep feeding liquidity, you got your speaking points this week. If you're in the camp that wants the Fed to start raising rates, you were equally satisfied with this week's comments. Here's what we're seeing so far this week...
Fed Comments Run the Gamut. The action started on Monday when Fed governors Bullard (St. Louis), Kaplan (Dallas), and Williams (New York) spoke at various events. Bullard and Kaplan signaled that tapering should begin sooner than expected. Williams provided the opposite opinion that tapering should be postponed and bond buying should remain in place. Atlanta Fed governor Bostic joined the hawkish group by stating on Wednesday that rate hikes should begin sooner. All of the governors, however, continue to suggest that the recent spike in inflation is "transitory." We disagree with this premise, simply for the fact that some elements of the economy will not be able to "undo" the rise in prices. For example, employers are willing to pay a premium to fill the more than 9 million job openings in the economy. As a result, wages will be on the rise. Lower wages will not result until the economy reaches "full employment" (sub-5% unemployment), or we head into recession. So, higher wages are likely to continue for some time. Yet, Fed Chairman Powell indicated on Tuesday that inflation has risen due to higher used car prices, airplane tickets, and hotel prices as a result of the economy re-opening. He stated that these factors "will ultimately start to decline and we are "very, very unlikely" to suffer 1970s-like inflation. This seemed to settle markets from the Taper Tantrum 2.0 we experienced last week when it was revealed the Fed signaled rate hikes in 2023 instead of 2024.
New "hawkish" stance seen in the Fed's latest economic projections shown in the graph above. Economic Growth was increased by the Fed from 6.5% this year to 7.0% and higher in 2023 from 2.2% to 2.4%. The Fed also increased their Inflation expectations from 2.4% this year to 3.4% and slightly higher in both 2022 & 2023. Unemployment expectations by the Fed were lowered to 3.8% in 2022 & 20233 from 3.9%, while leaving it at 4.5% for this year. This was the reasoning behind the Fed showing 2 Rate Hikes in 2023, when the Fed previously has shown no hikes until 2024.
Economy Healing. Meanwhile, the economic picture has been positive overall this week. While Weekly Jobless Claims disappointed today, the number was still slightly lower than last week. New Home Sales disappointed, but Existing Home sales surprised the market by exceeding expectations. The Richmond Fed Manufacturing index improved month-over-month, and the Chicago Fed National Activity Index went from negative in April to positive in May. Durable Goods Orders, a measurement of the change in the total value of new orders of manufactured goods, was lower than expected, but much higher month-over-month, also moving from negative in April to positive in May. Today, we get the trifecta of of consumer behavior statistics - Personal Income, Consumer Spending, and Consumer Sentiment. Sentiment is expected to tick up slightly. Income was still in the negative column, but improved over April and less than market expectations. Spending did not hold steady and did not grow during May. We expect June's Consumer Spending number to improve as Redbook numbers indicate a pickup in same-store sales this month. Despite higher prices at the pump, demand continues to be strong as consumers travel for vacation. So far, for the month of June, U.S. Crude Stockpiles have declined by more than 23 million barrels - the largest monthly drawdown since August of last year. While we often highlight the Fed's National Financial Conditions Index, we rarely highlight the different components of the Index (totaling more than 100 data series). The latest reading of the NFCI shows that 65 of the different components of the index loosened over the past week and that 104 of the 105 components are looser than average. A healing economy we have indeed.
How Should Investors Handle Rising Inflation? Rising inflation, whether transitory or not, is something investor are going to have to face. For the last 20 years, inflation has been running below the historical long-term average. Since 2001, inflation has averaged 2.1% per year. In the 20 years prior to 2001, inflation averaged 3.8%, which is closer to the long-term historical average of 3.5%. In the graph below, equities are the best long-term hedge against inflation, more than doubling the long-term average. For retirees over the past 20 years, inflation has not been a concern for portfolios port-retirement. Going forward, that might not be the case. As such, retirees would be wise to keep equities in their portfolio to stay ahead of eroding returns (see the 60:40 mix below - 60% equities and 40% bonds). What is evident over the past 20 years and in the 4 periods of rising inflation since 1988, cash is not a suitable investment to combat inflation.