Gill Capital Partners Update
Fed Meeting Recap & Market Reaction
We know the market volatility and headlines from the past few days can be unsettling, and we wanted to provide a brief update following this week’s Federal Open Market Committee (FOMC) meeting. We received new information as it pertains to interest rate policy and expectations, and more importantly wanted to outline why the market did not like what it heard following these meetings.
FOMC Meeting Highlights and Updates
As was widely anticipated, the FOMC raised the target Federal Funds rate by 75 basis points to a target range of 3% to 3.25%
Most importantly the FOMC updated their guidance on future rate hikes, increasing the terminal level from 3.75% to a range of 4.5% to 4.75% in 2023.
Chairman Powell reiterated his focus on doing whatever is required to contain inflation. He highlighted the positive trend of lower inflation, but reiterated they need to continue to see steady improvement in the overall inflation picture.
Chairman Powell also stated they will remain highly data dependent and will adapt policy as they receive more information.
Market Reaction
Equity market have moved lower following the more aggressive tone.
Interest rates have moved higher with 2-year Treasury yields trading above 4%, a further inversion of the yield curve.
The U.S. dollar has continued to strengthen and is now at the highest level since 2002.
Our view – This was not the forward-looking guidance that the market was hoping to hear. While markets dislike high inflation, they despise higher interest rates, and specifically rapid moves higher in interest rates. The increase in rates has been swift and relentless the past couple of weeks, as markets recalibrated based on forward looking expectations. Short-term interest rates and mortgage rates are now at the highest levels since 2007. The Federal Reserve is attempting to walk a fine line of restoring confidence in markets that they are serious about bringing down inflation, while also being cognizant of the fact that doing so will likely lead to slower economic growth, higher unemployment, and a weaker housing market.
On a positive note, inflation expectations are dropping, and market pricing suggests that inflation will moderate relatively soon. Many economists believe that the Federal Reserve should quickly look to pause further hikes to allow the economy time to digest the significant actions that have already been put in place. The Federal Reserve will be very focused on forthcoming data that is likely to show lower inflation and a slowing economy and could lead to a softer tone, which would be a tailwind for both stocks and bonds.
The bond market has rapidly priced in the updated guidance, and as such, bond yields are at levels we haven’t seen for some time. Fixed income investors can now lock in fixed returns that are accretive to overall portfolio returns. With inflation likely to moderate over the coming months and the anticipation of weakening economic data, we think it is reasonable to assert that interest rates markets and the Federal Reserve may have over done it a bit here.
We have been asked recently how this period is different than the Great Recession and the market correction of 2008 & 2009. In short, this is an entirely different economic backdrop, and many of the issues that led to the steep correction in 2008/9 are not prevalent today:
2008/9 was a liquidity crisis for consumers, businesses and most importantly banks, that were massively over-leveraged. This is not the case today. Bank balance sheets are considerably stronger, as they are now required to operate with significantly lower leverage and increased capital reserves. Corporate and consumer balance sheets are also dramatically healthier than they were leading into 2008/9. As an example, household debt ratios peaked in Q4 2007 at 13.2%. Today the household debt ratio is near the lows of the past 40 years at just over 9%.
The Great Recession was also a story of sloppy lending and credit standards. Lending and underwriting standards are dramatically more stringent since that time, leading to a healthy credit market.
Today’s economic environment is one where excesses, related to pandemic relief programs are being removed and labor/supply chain issues that resulted from the pandemic are correcting themselves.
We know market volatility and bad headlines can be stressful and disconcerting. We also know that these market cycles will run their course and investors will be rewarded over time. What are we doing right now? We will continue to rebalance portfolios to their long-term targets, specifically reinvesting and rebalancing bond portfolios to take advantage of dramatically higher yields to provide durable, high-quality income. Where appropriate, we are monetizing this period of volatility by harvesting tax losses. We are always here if you want to talk about what is going on in the markets, your portfolio or just commiserate.
As always, please let us know if you have any question or concerns, or if we can provide assistance with any other financial planning matters including education, taxes, insurance or estate needs.