When uncertainty soars and the narrative changes, financial markets can whipsaw investors. This week is a classic example of that.
The rollercoaster uncertainty around Omicron sparked volatile swings in stock, bond, and commodity markets worldwide. And then Federal Reserve Chairman Jay Powell contributed to the turmoil by changing the interest rate narrative. He endorsed a faster unwinding of the bank’s purchases of bonds as he jettisoned a ‘’transitory’’ view of inflation, opening the door to rate hikes.1
Powell’s inflation pivot is a recognition of the price pressures that come with a booming U.S. economy. Fourth quarter GDP is now pegged at 8.6% in the Atlanta Federal Reserve Bank’s GDPNow Forecast.2 It moved up after last week’s economic data showed that incomes continued rising in October and spending spiraled higher.3 Together, that’s a potent fuel for persistent inflation. If the 8.6% forecast turns out to be accurate, it would be the strongest quarterly GDP reading in 38 years, or since Q4 1983 (NOTE: the stat excludes last year’s massive, pandemic-affected GDP swings).
Last week’s report from the Bureau of Economic Analysis showed:
- Americans are still buying the durable goods that they splurged on during the pandemic despite still-high prices; spending in that category grew by 3.3%.
- Services spending rose 0.9%.
- Personal incomes rose as wage increases offset smaller unemployment checks.
- The savings rate of 7.3% remains at a historically healthy level, suggesting Americans still have the financial firepower to shop some more.
Americans continue to buy appliances, furniture, new and used cars, and pricey homes. Such strong spending despite the well-known supply chain delays and multiple sticker shocks is contributing to inflation remaining uncomfortably high for longer than many would have expected. Moreover, last week’s data indicated there’s no end in sight.
Turning to Omicron, it’s likely a lose-lose situation in terms of inflation. If the threat increases, it could spark higher prices by hobbling supply chains again. On the other hand, a fading of Omicron green lights another round of economic reopening, which could exacerbate the current problem of too much demand oustripping inhibited supply.
In light of the economic data and Omicron, Powell likely had little choice but to retire the central bank’s ‘’transitory’’ view of inflation.
Painful as it may be, a Federal Reserve interest rate hike may be precisely what the U.S. economy needs. Higher rates may cool Americans’ willingness to pay seemingly any price for goods and homes, relieving the pressure on businesses to raise wages to attract the workers they need to meet seemingly insatiable consumer demand. And that, in turn, may put a chill in inflation’s streak of hot readings.
What’s an Investor to Do?
First, we don’t see a need to panic or rush to make changes to your goals-based plan simply because Powell is closer to raising rates and inflation is currently high. In our view, the prospect of a moderate amount of interest rate hikes that lifts the Fed Funds rate off of 0% is unlikely to derail equity markets given GDP growth and corporate earnings are as strong as they currently are. And based on what we currently know, the potential rate hikes next year are unlikely to be large enough to alter the fact that bond yields remain at historic lows. Lastly, inflation is inherently hard to predict, as this year has amply shown. Other forces are at work, we noted November 18, which may turn the tide.
Gain Stage Investors: Our flexible, active approach to investment management is designed to help navigate the uncertainty surrounding consumer spending habits, the Federal Reserve’s interest rate path, and the pandemic’s twists and turns. Horizon believes equities can be more resistant to long-term inflation relative to other asset classes. As gain stage investors typically have a longer-term time horizon, reliance on equity markets can match the duration of their goal.
Protect Stage Investors: The change in the Fed’s rate hike timeline and inflation’s trajectory may increase volatility in both equity and fixed-income markets. It may be a good idea to talk to your advisor about employing risk mitigation techniques and the potential results from them..
Spend Stage Investors: Horizon Investments believes a higher exposure to equities than what is traditionally called for in this stage can better offset inflation than fixed income. As inflation is a large risk to investors who are distributing assets, investing in a strategy with exposure to equities and optimized towards desired spending rates has the potential to help investors meet their needs.
1 Wall Street Journal, “Powel Lays Groundwork for Faster End to Stimulus as inflation Outlook Worsens,” Nov.30, 2021
2 Federal Reserve Bank of Atlanta, atlantafed.org
3 Bureau of Economic Analysis, BEA.gov, “Personal Income and Outlays, October 2021”
This commentary is written by Horizon Investments’ asset management team. For additional commentary and media interviews, contact Chief Investment Officer Scott Ladner at 704-919-3602 or firstname.lastname@example.org.
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