Market Pulse: The Fed and you
Special to the Tribune
Fed chief Jerome Powell, in testimony on Capitol Hill, reiterated that interest rates will remain low. What we never hear from the Fed is an admission that the marketplace is much larger than the central bank.
When global investors believe that interest rates don’t adequately allow for inflation they sell, bond prices fall and yields rise until the picture improves.
Just the opposite occurs when rates are too high. In other words, the marketplace dictates to the Fed, not the other way around. We are seeing that play out again. The rate on the 10-year Treasury hit a low of 0.6% last summer. Today it is 1.66%. The market is telling us that investors are not convinced that Fed policy is correct, that it adequately addresses the inflation risk, or that it will stay in place. Words alone are not enough.
Fed Chief Powell expects short-term rates to stay where they are through 2023. Never mind rising commodity prices, the fast expanding money supply and the surging demand for credit from the private sector and especially from the Treasury to finance trillions in new spending. The impact on inflation will be “transitory,” he said, and soon reversed. Convincing skeptical investors while economic growth is solid and accelerating will be no easy task.
Powell described what would prompt a change in plans. The unemployment rate must fall to its pre-COVID level (3.5%) and stay there for some time. Inflation, which can stay above the Fed’s 2% target for months, must fall back to it.
Here’s my take on the Fed. Inflation wary bond investors will drive long-term rates higher if they see an increasing inflation risk until the Fed raises short-term rates. Count on them.
Recall that 40 years ago the 10-year Treasury yield rose to 14.5% and mortgages were 18.5% amid surging inflation. Paul Volcker beat inflation by pushing short-term rates to 20%. Sky-high rates were needed then. They aren’t needed now. I trust the bond crowd putting their own money on the line to keep the Fed focused on inflation.
Stock investors, as always, are focused on future earnings growth in the environment they foresee. Earnings growth will be impacted by a rise in corporate taxes and higher interest rates. I am not painting a bearish picture, but there are some approaching headwinds. Still, money has to go somewhere. Until rates rise enough to make bonds more attractive stocks will be the place to be. We are not there yet. Not even close.
David Vomund is an Incline Village-based Independent Investment Advisor. Information is found at http://www.VomundInvestments.com or by calling 775-832-8555. Clients hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial advisor before purchasing any security.
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