So Much for a Soft Landing

Wild market swings following news we knew was coming? Call it just another day in the market.

U.S. stocks yo-yoed in the final hours of Wednesday’s trading day after the Federal Reserve announced another interest-rate hike, with major indexes closing nearly 2% down after rallying during Fed Chair Jerome Powell’s press conference earlier.

As anticipated, policymakers raised the fed funds rate by 0.75% for the third consecutive time—the most aggressive inflation-fighting approach we’ve seen since Paul Volcker’s 1980s Fed. At 3.00% to 3.25%, the benchmark—against which everything from car loans to Treasury bill yields are set—is the highest it’s been since 2008.

Despite the Fed following through on a well-telegraphed policy move, stocks have continued to decline. We believe traders now fear recession more than inflation. But given that stocks had already fallen some 8% since Powell’s speech last month (where he explicitly committed to hammering inflation down to the Fed’s 2% target), why did they drop further on the news?

Traders apparently took the Fed’s signal that it will continue to fight inflation aggressively as a negative. Officials anticipate hiking the fed funds rate by another 1.25% before 2022 ends, though this isn’t a guarantee. On top of that they also cut their estimates for future economic growth. Add it up and stocks went down.

Here’s what else we’re focused on and why it matters:

• The yield on two-year Treasury bonds peaked above 4.1% intraday for the first time since 2008 while the 10-year Treasury’s yield dropped—the gap between the two is wider than it’s been since 2000. While historically an inversion of the yield curve has not been a sell signal for stocks, it does indicate that bond traders are expecting an economic slowdown, something confirmed by the Fed governors’ latest projections.   
• After 98 consecutive daily declines, the average price of gasoline at the pump ticked up slightly on Wednesday. With all the inflation talk, where do things stand for consumers? Energy prices are notoriously volatile, so we’re not going to predict where they go from here, but if prices keep rising, it could force some to rein in their holiday spending plans.
• Housing costs, which have been rising quickly, are a huge part of most consumers’ budgets and a key source of inflation. We got some good news on that front. Rents are (finally) showing signs of cooling, with the national median rental price advancing “only” 11% year-over-year in August—the smallest increase in a year, according to real estate giant Redfin. And there may be more relief ahead for renters as builders address a dearth of supply. Construction on multifamily units is up more than 30% compared to a year ago. A higher supply of rentals should eventually translate into lower rents.
• Sticking with housing for a moment, mortgage rates are at 14-year highs and, not surprisingly, that’s cutting into home sales, which fell nearly 20% from a year ago in August. Despite persistently low supply, prices have started to come down as well, declining month-over-month for the second month in a row. The hot housing market has been due for a cooling-off period and it looks like it’s begun.

Fed Flexes Muscle, Admits Uncertainty

The Fed’s calculus is simple in theory: Keep the pressure on with higher interest rates until businesses and consumers get the message, which is intended to result in slower wage growth and cooling demand, thereby bringing down inflation. How much interest-rate discomfort will it take to get to the 2% inflation the central bank vows to be “strongly committed” to achieving? And will the strategy actually work?

Confidence in central bankers’ ability to engineer a “soft landing”—slowing the economy and taming inflation without sparking a recession—has started to wane. Yet, on average, policymakers still predict 1.2% GDP growth in 2023 (though this is down from the 1.7% growth rate forecast in June). Their collective view is that a soft landing could still be in play. The Fed sees unemployment remaining near 4% over the next few and inflation dropping to nearly 2% by 2025.

We’d never accuse Chair Powell and Co. of being Pollyannaish—he said Wednesday that “no one knows if this process will lead to a recession”—but maintaining growth and low unemployment while bringing inflation down would be a pretty good trick. We’ll be rooting for him, and we’re always here to help your portfolio and financial plan endure whatever comes.

Signal From Static: The Chairman’s View

Co-founder and Chairman Dan Wiener: 

Adviser was founded in 1994 because investors demanded an independent, uncompromised view on the markets, the economy and their finances, delivered in both words and actions. We have tried to live up to those demands and have been rewarded with fantastic clients and a terrific team of people to help them.

One of our fundamental beliefs echoes the slogan of a 1960s retail phenomenon named Sy Syms, who said, “An educated consumer is our best customer.” All of us at Adviser believe that an educated investor is our best client and partner. We have always been “The Adviser You Can Talk To.”

Whereas Sy Syms was selling men’s suits that, not surprisingly, went out of style and lost their fit over time, I believe many of the fundamentals of saving, investing and planning for your financial future are timeless and never wear thin. That is one reason why we also review these financial fundamentals in our weekly email missive to you.

In Signal From Static, a new feature in our update, I’ll try to take a broader view on issues and questions of finance, cutting through a lot of the noise and keeping an eye on how events impact our company’s most important stakeholder—you. I hope what I have to say will be of interest, and if I ever fail or miss a particular topic you want me to focus on, please email me at signal@adviserinvestments.com.

An Inflated Perspective: Why 2%?

Consumers, as well as investors, have become obsessed with inflation (the media certainly has helped). I’m not surprised. After decades of prices rising at a snail’s pace, the measure has shot higher, with the headline consumer price index (CPI) hitting 9.1% in the year ending in June. (It has since fallen to 8.3% but that’s not a win as yet.) The monetary policymakers at the Federal Reserve have begun to battle inflation with interest-rate increases, and their goal is 2% inflation sometime in the next two years.

You might wonder where that 2% figure came from. It was only in 2012 that the Fed agreed to publish a target for its policymaking. Prior to that decision there was disagreement about whether it should target anything. The 2% figure, which is based on the headline personal consumption expenditures (PCE) measure rather than the CPI, has become an international standard of sorts, according to researchers at the St. Louis Federal Reserve. Several countries have adopted 2% as their inflation targets as well.

As investors, we need to put the Fed’s target in perspective. I believe they are setting an unrealistic goal for policy. Inflation at 2% would be significantly lower than Americans have seen, on average, for decades. In fact, I believe the only reason many of today’s pundits think a 2% inflation level is the “right” target is because they are suffering from recency bias. Since the end of the Great Recession in June 2009, PCE inflation has averaged 1.87%, inclusive of 2022’s recent inflationary spike. Ignore the past 12 months and the Fed’s favored inflation measure has averaged just 1.53% since 2009.

Inflation has been abnormally low for more than a decade. This gives the Fed cover for its 2% figure. Why do I say that? Because since the PCE was first calculated in 1960, inflation has averaged 3.27% over more than six decades. A goal of 2% inflation may be laudable, but that doesn’t mean it’s obtainable.

Investors and consumers must recognize that even if inflation doesn’t fall to 2% the economy will not go into a tailspin, and we won’t be forced to buy generics to keep our household budgets under control. Incomes are rising and bonds are paying much higher rates of interest today than we’ve seen in over a decade. Forward-looking inflation expectations are reasonable, but they aren’t at 2%.

Investors are often biased by recent experience. If the markets have been strong, they expect them to remain strong. If they’ve been weak, that weakness is expected to continue as well. Those are the biases we must contend with. The same applies to inflation. We may have been through a period of below-average inflation; now we’re faced with a period of well-above-average inflation. The pendulum is already swinging back in favor of lower price increases. Will inflation reach 2%? I have no idea, but I’m not going to hold my breath.

In the meantime, as with stocks, the only thing we need now is patience.

Until my next static-clearing signal…

Dan Wiener

Rising Rates Hit Home

Senior Research Analyst Liz Laprade: 

The 30-year fixed-rate mortgage has edged up to near 6% over the last month—a level we haven’t seen since 2008. What gives?

Interest-rate hikes play into higher mortgage rates, but only indirectly. There’s a bit of a domino effect: The 30-year fixed rate tends to track the 10-year Treasury yield—which, as we saw above, has been rising as bonds sell off and yields rise. This, in turn, is partly in response to the Fed’s ongoing tightening policy as it battles high inflation.

Even with rents cooling off, as mentioned above, higher mortgage rates could eventually spell trouble for renters, prospective homebuyers or even some existing homeowners.

High food and home heating costs were already causing a struggle, and now it’s also pricier to pay a variable rate mortgage. The typical monthly mortgage payment today is roughly $2,300—up about 65% from the $1,400 average payment of a year ago. Higher home prices have contributed to the jump, but rates play a material role as well. And opportunities for refinancing narrow as rates climb.

Prospective homebuyers can’t catch a break either. Even as home prices trend lower in some areas, the decline has not been enough to offset rising mortgage rates. And as people get priced out of buying homes, they’re forced to rent, handing more pricing power to landlords.

Homeowners with fixed-rate mortgages are in better shape, but they’re not entirely immune. If rising rates start putting real pressure on home prices, well, the value of your home might decrease.

The takeaway is that we will be living with this for a while longer. The Fed has signaled its commitment to taming inflation. Until that happens, consumers struggling to pay for shelter or planning to move will remain in wait-and-see mode.

Podcast: Inherited IRAs—What You Need To Know

IRAs are one of the best tools we have for both saving for your retirement and passing wealth on to your heirs.

In this week’s podcast, Manager of Financial Planning Andrew Busa and Tax Associate Cathy Lee are here to guide you through what you (or your heirs) need to know about maximizing the value of an inherited IRA—and avoiding the snares of the IRS.

Click here to listen now!

Ask Us a Question!

We’re always interested in the topics or concerns you might like us to comment on. As much as we try to cover the investment and economic fields every week, we know there’s still more that you might want to hear about. Ask us a question about investing, the markets or financial planning and one of Adviser’s wealth management or investment specialists will answer it in a future edition of The Week in Review. CLICK HERE NOW TO POSE YOUR QUERY.

Adviser in the Media

Portfolio Manager Adam Johnson appeared on Cheddar News to discuss the silver lining behind the Fed’s rate hike.

In this week’s Adviser Takeaways, Senior Research Analyst Liz Laprade talked about rising mortgage rates while Account Manager and Financial Planner Diana Linn provided an overview of the 50/30/20 rule for saving and spending.

Looking Ahead

Next week, we’ll get helpful reads on inflation, manufacturing, home prices, new home sales, and the state of the American consumer, including spending, income and sentiment.

As always, please visit www.adviserinvestments.com for our timely and ongoing investment commentary. In the meantime, all of us at Adviser wish you a safe, sound and prosperous investment future.

About Adviser

Adviser is a full-service wealth management firm, offering investment management, financial and tax planning, managed individual bond portfolios, and 401(k) advisory services. We’ve been helping individuals, trusts, institutions and foundations since 1994. Adviser Investments and its subsidiaries have over 5,000 clients across the country and over $8 billion in assets under management. Our portfolios encompass actively managed funds, ETFs, socially responsible investments and tactical asset allocation strategies, and we’re experts on Fidelity and Vanguard mutual funds. We take pride in being The Adviser You Can Talk To. To see a full list of our awards and recognitions, click here, and for more information, please visit www.adviserinvestments.com or call 800-492-6868.