Matt’s Chart of the Week
The Fed Wants to Avoid Catching Another Wave
With inflation continuing to last longer than initially expected, we see an increased recognition by investors that recession is that the Fed may need to create a more protracted or serious recession to stem the tide of inflation and bring inflation back down. With this recognition, over the last month or so, Treasury rates across the board increased to decade-long highs and stocks declined to year-to-date lows.
Given the Fed’s central role in the U.S. economy, we read an equal number of analysts, politicians and economists blaming the Fed for not acting sooner as those saying the Fed is causing more economic pain than necessary by raising rates too quickly. Rather than play the “blame game,” we try to understand the Fed’s motivation, so we can predict what they’re most likely to do and whether the market matches those expectations.
In this case, we believe the Fed’s historical memory is anchored on avoiding the 1970s even if it’s arguable whether that period is indicative of the current inflation crisis. During that decade, we saw multiple waves of inflation, including many periods where folks thought inflation was under control. Given that history, we believe that unless we get a severe recession, the Fed is unlikely to lower rates until it is clear that inflation will not rear its head again. However, the market, on average, still expects the Fed to start to lower rates as early as late next year.
As a result, we believe short to intermediate-term bonds held to maturity offer the best safety right now for the more conservative part of a portfolio. With two-year rates higher than ten-year rates, we can pick up more income while reducing the risk that rates may need to go even higher post-pause in order to avoid a second wave of inflation. For now, it’s time to follow the path the Fed has laid out, whether we like it or not.
This material is provided for informational purposes only and is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are subject to change at any time without notice. The information and opinions contained in this material are derived from proprietary and nonproprietary sources we deemed to be reliable and are not necessarily all-inclusive. All investing involves risk, including the possible loss of principal.