Fed Inflation Mission Accomplished? Not So Fast

Punxsutawney Phil saw his shadow early this morning in Western Pennsylvania—calling for six more weeks of winter. At an even more widely observed predictive event on Wednesday, Federal Reserve Chair Jerome Powell suggested that inflation may have failed to see its shadow (“disinflation” in Fed speak, a decrease in the rate prices are rising), though policymakers are disinclined to stop hiking rates.

Wall Street was not dissuaded by the Fed’s cautionary tone at the policy briefing, instead seizing on the “slowing inflation” theme, and the S&P 500 rallied 1% while the growth-oriented NASDAQ gained 2% on the day.

Before Powell’s comments, the Fed executed its eighth interest-rate increase in less than 12 months in the ongoing battle against inflation—amid clear signs that its policy approach is succeeding. After a string of unusually steep 0.75% hikes, yesterday’s anticipated 0.25% increase came on the heels of a 0.50% bump in December. 

So has the Fed successfully navigated the “soft landing” of taming inflation while avoiding both recession and capsizing the labor market? So far, so good. But we’re not there yet.

Here’s what else we’ve been watching this week and why:

• At the Fed policy press conference, Chair Powell noted that a slowing rate of inflation hasn’t come at the expense of a weaker labor market. He also cautioned that the disinflationary process is “at an early stage” and additional rate hikes are likely this year, saying, “We’re going to be cautious about declaring victory.”
• Unemployment remains near 50-year lows and job openings are plentiful—nearly two open positions for every unemployed worker. Data this week did show some signs of a slowdown in the labor market despite overall strength. Notably, wage growth slowed in the fourth quarter coming off of the highest levels in at least 20 years, according to the Labor Department. Since wage inflation contributes to higher prices throughout the economy, any signs of slowing reinforce the theory that overall inflation may be turning a corner.
• The beleaguered housing market is one area of the economy where inflation has been tamped down by higher interest rates. Home prices declined in November for the fifth straight month. Prices were still up 7.7% from November 2022, but that’s down from a 9.2% annualized rate in October. Overall, sales of previously owned homes fell 17.8% in 2022. But there are early signs the housing market may have found its nadir. It’s a short-term move and not necessarily yet a trend, but lumber prices are up over 35% year to date, as demand for building materials has risen.

Chart of the Week: Are Bonds Back?

Senior Vice President, Fixed Income Manager Chris Keith 

You’ve probably heard by now—2022 was the worst calendar year on record for bonds. But what you may not know is that the bond market recorded its second-best January of all time, kicking off 2023 with a 3.1% gain.

The strong start to the year restores confidence to bond investors who were understandably disappointed with how this “safe” asset class performed last year.

Right now, two questions come to mind when assessing recent performance:

1. Have we seen a market bottom for bonds?

We don’t make these kinds of calls at Adviser, but we like where we are right now. If in fact the bottom is in, then it occurred in late October 2022. Since then, bonds have returned 7.8%.

There’s more ground to make up, but just as bonds didn’t drop all at once, neither will they recover all at once.

Thanks to the higher yields born from last year’s sell-off, investors who reinvest interest, dividends and principal as bonds mature are benefiting not only from higher income, but also from prices trending higher. It was challenging at times last year, but we had a high degree of confidence that bonds would once again add value to investor portfolios. That has been the case over the last few months.

2. How is it that bond prices are rising if the Federal Reserve is still hiking?

Investors seem to believe the Fed will eventually need to reverse course on its interest-rate policy. Hence, they are pricing a lower fed funds rate into the markets now. When investors anticipate lower interest rates, and thus lower yields, prices rise on bonds. This theme is contributing to recent gains.

It is our belief that the Fed will get to a point where it stops hiking and then stand pat without cutting rates—the “higher for longer” mantra we hear some analysts embracing. The job of wrangling inflation down to acceptable levels has begun, but it’s not over. If the central bank acts in accordance with its messaging to date (and I have every reason to believe it will), we’ll see lower interest-rate policy once inflation is in check.

My takeaway: Bonds have been pulling their weight again over the last few months, delivering higher income and positive total returns. Investors who have locked in higher yields should benefit from that higher level of income even if prices turn lower unexpectedly. 

Understanding the Alternative Minimum Tax

Manager of Financial Planning Andrew Busa MSPFP, CFP®, MPAS®, CCFC

Financial Planner Michael Dillaire, CFP®

If you’re a fan of the Netflix show Stranger Things, then you’re familiar with the concept of the Upside Down. Congratulations! You’re already halfway to understanding how the alternative minimum tax (AMT) works. 

If that pop culture reference means nothing to you, here’s what you need to know: The AMT functions in a kind of parallel universe to the normal income tax, with different rates and methods of calculating income and deductions. People who fall into a specified income range must calculate both their normal income taxes and the AMT—and then pay whichever is higher. 

Under the current tax structure, those who may be affected by the AMT are:

• Families and individuals with taxable income above $1 million with a significant amount of Schedule A deductions
• Those who realize a large capital gain like selling a home
• Those who exercise incentive stock options (or ISOs)

The Tax Policy Center reports that the number of taxpayers in the U.S. impacted by the AMT in 2018 was 200,000—but that number will almost certainly rise exponentially in 2025 if the Tax Cuts and Jobs Act (TCJA) expires as scheduled.

So, what can you do to mitigate your exposure to the AMT? 

Carefully consider your deductions. Pretax retirement plans (traditional IRAs, 401(k)s, 403(b)s, etc.) will reduce your total income—so stuff those retirement accounts!

Time your income. Accelerate or defer income (by selling stocks, taking your bonus or considering a Roth IRA conversion) to stack lowered income years when you anticipate a jump or drop the following year.

Be strategic with incentive stock options. Exercising ISOs does not impact your “regular” income tax, but it does affect your AMT calculation. Any AMT you pay from exercising an ISO is eligible for the AMT credit on Form 8801—and it could be a valuable lever you can pull to reduce income tax in future years. Keep in mind, however, you can only use the AMT credit for tax years when you are not paying it.

The AMT is an unfortunate reality you may find yourself trapped in. But our tax team can help you sort it out. If managed carefully, the AMT shouldn’t throw you off track for your financial goals.

Welcome Tim Clift, Chief Investment Officer!

We are thrilled to announce Tim Clift has joined Adviser as chief investment officer leading our investment strategy and research team. Tim came to us from the financial technology firm Envestnet, where he most recently served as chief investment strategist.

“I am enormously excited to join Adviser to lead an already exceptional team,” Tim said. “I think you’ll see our strategy lineup evolve, as innovation in our industry has created more robust investment products and tools to complement our broader lineup of services.”

For much more from Tim, tune in to our latest podcast to hear his perspective on the markets, inflation, recession and the debt ceiling.

Webinar Replay: From Recession to RMDs—Our 2023 Outlook

This week, in our first webinar of 2023, Wealth Adviser Liz Kesselman joined Chief Investment Officer Tim Clift and Manager of Financial Planning Andrew Busa, CFP^®, to review our outlook following the 2022 bear market, recession do’s and don’ts, and what’s changed with Secure 2.0. The trio also answered audience questions on Federal Reserve policy, cash holdings, inherited IRAs and more.

Click here to watch it now!

Adviser in the Media

Portfolio Manager Adam Johnson visited Fox Business to discuss this week’s Fed meeting and what it signals for interest rates.

In our most recent Adviser Takeaways, Senior Research Analyst Liz Laprade explored the debt-ceiling dilemma’s impact on the bond market, while Manager of Financial Planning Andrew Busa looked at the alternative minimum tax.

Looking Ahead

Next week brings useful reads on inflation expectations, consumer credit, wholesale inventories and consumer sentiment. We’ll also continue to parse a flood of fourth-quarter earnings reports for insight on how companies have done and where corporate leaders see them headed.

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