Investors have seen equity markets reacting starkly negatively to the Fed’s belated inflation response. Much of this selling pressure is believed to be on the anticipation that the U.S. economy will slip into recession between the next 9 to 15 months if it is not already there. Most economists believe that the U.S. economy is currently too strong to move into recession this year, while most Americans believe that the country is already in a recession.
On June 15, the Federal Reserve announced a 75-basis point increase in the Fed Funds rate, the largest Fed increase since 1994. The Fed is raising rates to combat inflation, which is running at a 40-year high. The move to raise rates more aggressively represents a significant shift in the perceived balance of risk in the U.S. economy. Noticeably absent in the Fed’s statement was any mention of the poor stock market performance and weak bond market performance this year. Previous announcements had been an attempt to use “soothing words” when the market declined, and those pullbacks were not as severe as the current one. The Fed is now an “inflation first” committee. Just last month Fed Chairman Powell stated, “a 75-basis point increase wasn’t on the table”. It’s possible that the recent massive upward spike in Treasury bond yields forced the Fed to re-think its slow approach to rapidly increasing inflation; both the two-year Treasury and 10-yr Treasury have reached over 3.4%. The Dow Jones Industrial Average observed two consecutive 800+ point declines following the 8.6% increase in CPI on June 10th.
On an interesting note, after the announced rate increase the equity markets bounced back and had a sharp move upward. Typically, higher interest rates are a headwind to growth in equities as other asset classes become more attractive. It seems in this instance the bold move by the Fed was well received as a sign they are serious about curbing inflation. The Fed is now being forced to prioritize the taming of inflation over supporting growth after many years of doing the latter.
Select SPDR reports the week ending June 16th witnessed the S&P 500 drop 5.1% amid heightening fears that inflation is getting worse. The May Consumer Price Index rose 8.6% for the month, up from April’s 8.3%, the fastest increase year-over-year since 1981. Core CPI which excludes the more volatile food and energy prices, rose by 0.6%, faster than was estimated but equal to the April rise of the CPI. Energy costs rose 3.9% month over month, 36% YTD and food costs rose 1.1%, 9.7% YTD. According to the Daily Speculator, both increases have now impacted the affordability of low-income households and political pressure is mounting for the administration to do “something”. Airfares have now risen 12.6% month-over-month and 36% YTD. Both used and new cars also saw prices increase after a month of declines.
The RMR Investment Committee reduced the duration on our fixed income sleeves earlier this year. The move to shorter-duration bonds offers greater safety during rising rate periods, along with the potential of increased income, as the shorter bonds come due and are re-invested into higher-yielding bonds.
Keeping it in Perspective: Try to keep calm and diversified
First Trust presented a chart showing the average Bull Market versus the average Bear Market going back to 1926. A $10,000 investment in 1926 fell to $5,000, a 50% loss following the Depression. That same initial investment would have grown to an inflation-adjusted $7 million today, despite the numerous bear markets along the way. Remember, “it’s time in the market”, not “timing” the market that has proven to be the most successful strategy. The longer the time frame – through highs and lows- the greater the chances of a positive outcome.
Average Bull Market Average Bear Market
Average increase of 476% Average Decline -of 41%
Average Duration- 9.1 years Average Duration - 1.4 Years
Please do not hesitate to contact your RMR advisor should you have any questions regarding your account(s).
The RMR Investment Committee