Fight, Fight, Fight!

The Federal Reserve released its latest minutes yesterday and the ceremonial analyst tea leaf reading has commenced.

A hawkish turn on it’s way? Or forever easy money?

At first glance, it looks like a fight may be brewing about the Fed’s next move.

Let’s look at what information we can glean from the Wizard of Oz’s latest release…

Mixed Opinions 

Some Federal Reserve members expressed their beliefs that the economy is recovering much faster than anticipated, which is resulting in rising inflation the rate for the year ending in May 2021 stands at 5%! 

Because of this 13-year inflation high, some made the case for scaling back easy monetary policy.

The minutes noted that some officials “mentioned that they expected the conditions for beginning to reduce the pace of asset purchases to be met somewhat earlier than they had anticipated at previous meetings in light of incoming data.” 

Regardless, the overall consensus seemed to be that there would be no rush to reverse policy and the markets need to be well prepared for any potential changes. The thought process was that the FOMC “should be patient in assessing progress toward its goals and in announcing changes to its plans for asset purchases.”

According to the document released yesterday, most members agreed that the economy had not achieved the “substantial further progress” needed to adjust the Fed’s economic plans. 

What Exactly Is “Substantial Further Progress?”

Last year, the Fed created three conditions that would need to be met before raising rates. First, inflation would need to reach 2%. As we have already discussed, inflation is far above this target rate. 

However, the Fed tends to take its cues from the implicit price deflator for personal consumption expenditures, or PCE, which is currently 3.9%. Still above 2%, and a 29-year high, but not quite as terrifying at 5%. The Fed has reiterated that it believes the recent surges in inflation are temporary. 

Second, inflation would need to be forecast to run moderately above 2%. It would appear that recent remarks indicate the Fed suspects its goal of average 2% inflation has or will soon be satisfied.

Third, the economy would need to return to maximum employment, a standard that has not been explicitly defined by officials. The recent June job report showed payrolls are still 6.8 million short of pre-pandemic levels, so this could be the final detail holding the Fed back from moving forward more aggressively with policy changes.

Esty Dwek, head of global market strategy at Natixis Investment Solutions, explained, “One of the keys going forward is going to be the labor market. It hasn’t made enough progress” for the Fed to pull back on stimulus programs. 

So, What Now? 

The minutes from the meeting stated:

In coming meetings, participants agreed to continue assessing the economy’s progress toward the Committee’s goals and to begin to discuss their plans for adjusting the path and composition of asset purchases. In addition, participants reiterated their intention to provide notice well in advance of an announcement to reduce the pace of purchases.

For now, the $120 billion in monthly purchases of Treasury and mortgage securities are here to stay, and the benchmark rate will continue to fall between 0% and 0.25%. 

Many believe that Fed officials will begin more formal discussions for reducing bond buying at their next meeting, which is scheduled for July 27-28.

The Impact on the Markets 

The main U.S. stock indexes all rose modestly after the release of the minutes. The S&P 500 rose 14.59 points, or 0.3%; the Nasdaq Composite hit a record high, gaining 1.42 points, or 0.01%; and the Dow Jones Industrial Average added 104.42 points, or 0.3%.

As expected, bond yields continued to drop, with the 10-year U.S. Treasury note’s yield reaching a new low.

Investors have generally been encouraged by the Fed’s plan to leave current policies in place and have continued to propel market indexes into new records. 

However, the ongoing inflation, which has resulted in supply and labor shortages and is threatening economic growth, is worrying many investors.

Oliver Allen of Capital Economics stated, “While we doubt that the reflation and rotation trades are entirely dead, they may have now largely run their course.”

Now there are increasing signs that market growth is stagnating while inflation continues to rise. Peter Boockvar, the chief investment officer at Bleakley Advisory Group, points to the similarities between what is happening now and what happened during the “stagflation” of the 1970s.

David Rosenberg, chief economist and strategist at Rosenberg Research, agreed with Mr. Boockvar’s assessment. 

Mr. Rosenberg has put together multiple indexes, including a “stay at home” index, a “GDP recovery” index, and a “reopening index.” All three of the indexes are flattening out, which “indicates that the market is coming around to the view of ‘peak growth’ with a lot of the reopening and recovery news being fully in the price.”

The one index that is still rising is the “vaccine hope” index, which indicates that Covid-19 fears are still alive and well due to the Delta variant, which is continuing to spread. 

With yields at their lowest levels since February, investors are seemingly bracing themselves for slower continued growth. Kathy Jones, Schwab’s chief fixed income strategist, mused, “All that seems to be implying that perhaps not only was the inflation transitory, but maybe some of the growth has been transitory.”

If these experts are correct, you should prepare yourself by diversifying your portfolio. You may not be able to bank on growth stocks continuing the high returns we have been seeing during the majority of the economic recovery…

To a Richer Life,

The Rich Life Roadmap Team

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