CAMS Weekly View from the Corner – Week ending 5/6/2022
May 9, 2022
In recent months it has become customary to hear price inflation measures referenced back three to four or more decades in order to compare the last time society has experienced such levels of price increases.
This has become the topic du jour within society as it is hard to have a conversation without some mention of prices, be it explicitly as a topic on price inflation or simply embedded within you-name-it type of discussion.
Over the course of the previous year we have occasionally looked at, referenced, or literally pointed a finger at how far behind the “price inflation race” the Federal Reserve has been and still is.
This past week Fed Chairman Powell informed us the Federal Open Market Committee raised the benchmark interest rate by one-half percent. The Fed’s benchmark rate is known as the Fed Funds Rate.
This one-half percent increase was the largest one-time increase in rates by the Fed in over twenty years.
The significance of this is one-quarter percentage point moves has been the customary go-to for the Federal Reserve for the better part of the past two decades. The Chairman also suggested one-time rate hikes larger than one-half percent are not part of their forward expectation at this time.
In light of how far behind the Fed is in the price inflation storyline market participants and general economic observers had begun to question if they would need to start raising by say three-quarters of a percentage point at one time in order to catch up to help quell the inflation backdrop.
With Chairman Powell suggesting this would not be the case the stock market celebrated, post Fed-meeting, for the remainder of the day on Wednesday. Then, we suspect, participants had a realization that little had changed. That is, the Fed is still behind the price inflation race and with this the web of issues coming from this fact remains in place.
With this, stock prices retreated rapidly and by the close of the week most well known stock market indexes closed at low points for 2022.
For simplicity purposes, thinking of price inflation and the Fed’s benchmark interest rate as a race, we can put our current societal storyline into a historical visual.
Click For Larger View: https://fred.stlouisfed.org/graph/?g=OVS1
Being that we have heard price inflation numbers often referenced back forty years or more we dated the above visual back to January 1980.
The red line represents the Federal Reserve’s Fed Funds Rate while the blue line represents the Consumer Price Index which is a commonly referenced price inflation gauge.
Letting the visual speak for itself you can see how historically the Fed Funds Rate (red line) is above the Inflation Index (blue line) as a customary relationship.
Also note, as the 21st century opened up this relationship changed notably. Then as the past two decades have unfolded this relationship has become, shall we say, ridiculous relative to its forty-plus year historical context.
(We added the red vertical line to aid in visually separating the two centuries. If interested in a sixty-plus year visual to underline this historical relationship click here: https://fred.stlouisfed.org/graph/?g=P4On)
When you hear phrases or views such as “easy money,” “excessive speculation,” “absurdly low level of mortgage rates fueling housing speculation and pricing,” “free money,” “excessive printing of money,” “runaway inflation,” “stock market valuations that history cannot match,” the above visual walks you to the epicenter of these various referenced socioeconomic phrases and topics by those both in and out of economic circles. We digress here but the above chart begs for such a digression.
Back to the point of the Fed’s current day dilemma (and through them wage earners/consumers economic dilemma) when looking at the far right of the picture you can see the blue line launched higher in the previous year-plus while the red line has remained relatively dormant.
Even with last week’s increase of one-half percent by the Federal Reserve it is hard to see when compared on a chart to price inflation. In the forty-plus years in the above chart we have never seen such a disparity between the price inflation level and that of the Fed Funds rate.
When you hear “….The Fed is behind the price inflation curve…..” you can think of the above picture as a mental visual.
What’s to Come
There is a question in analytical circles as to how much the Fed will actually be able to raise interest rates before pushing the economy into recession.
If the Fed does as they say and merely increases interest rates by one-half percent will the price inflation line above be able to come down notably all-the-while seeing the economy hold up on a growth track?
Collective market participants have begun to send messages, across markets, that they are having doubts the economy will be able to continue growing if the Fed continues to increase interest rates, consistently, even if only one-half percent at a time.
This is a very fluid situation as we look out into the near-future with this question in mind and markets are reflecting this with their near face ripping volatility at times. One day up tremendously with the next day being down dramatically while the overall trend works lower.
On a personal note I have grown fond over the years of the phrase – “Stay nimble, be flexible.”
For our part in managing assets on an Active Management basis (known as Tactical Management) we have employed this phrase in droves along the 2022 timeline and will continue to do so. If you find yourself convinced of a forward outcome, in any direction, be careful with that as markets can and probably will surprise you every time you are convinced X will occur next.
I cannot think of a better phrase to apply to market participation for our current socioeconomic backdrop than the above. The Fed’s dilemma and hence society’s dilemma is going to get interesting as 2022 unfolds.
I wish you well…
Ken Reinhart
Director, Market Research & Portfolio Analysis
Footnote:
H&UP’s is a quick summation of a rating system for SPX9 (abbreviation encompassing 9 Sectors of the S&P 500 with 107 sub-groups within those 9 sectors) that quickly references the percentage that is deemed healthy and higher (H&UP). This comes from the proprietary “V-NN” ranking system that is composed of 4 ratings which are “V-H-N-or NN”. A “V” or an “H” is a positive or constructive rank for said sector or sub-group within the sectors.
This commentary is presented only to provide perspectives on investment strategies and opportunities. The material contains opinions of the author, which are subject to markets change without notice. Statements concerning financial market trends are based on current market conditions which fluctuate. References to specific securities and issuers are for descriptive purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. There is no guarantee that any investment strategy will work under all market conditions. Each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. PERFORMANCE IS NOT GUARANTEED AND LOSSES CAN OCCUR WITH ANY INVESTMENT STRATEGY.
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