This is a new installment in an ongoing series where Marc Bautis, Wealth Manager and Founder of Bautis Financial, comments on hot topics in the financial industry.
Rate Hikes and a Rocky January
The Consumer Price Index report for January was published today, and there are plenty of reasons why inflation is at a 40-year high:
- Easy money and low interest rates.
- Rising wages.
- Supply chain disruptions.
- Fiscal stimulus that has fueled demand for consumer goods.
…And all of this is happening at a time when food and energy costs are rising.
Last year, the Federal Reserve insisted the jump in inflation would be temporary – “transitory” was its word of choice. But as inflation proved to be more troublesome than expected, the term transitory was retired and the Fed quickly pivoted.
Gone are pledges to keep the Fed funds rate at near zero through at least 2023. Instead, Fed Chief Jerome Powell seems determined to bring inflation back under control, and that means the Fed is contemplating (moving forward with) a series of rate hikes in 2022.
His more aggressive approach created volatility in January, as investors attempted to price in several rate hikes this year.
Key Index Returns
|MTD %||YTD %|
|Dow Jones Industrial Average||-3.3||-3.3|
|S&P 500 Index||-5.3||-5.3|
|Russell 2000 Index||-9.7||-9.7|
|MSCI World ex-USA*||-3.3||-3.3|
|MSCI Emerging Markets*||-1.8||-1.8|
|Bloomberg US Agg Bond TR USD||-2.2||-2.2|
MTD returns: Dec 31, 2021—Jan 31, 2022
YTD returns: Dec 31, 2021—Jan 31, 2022
The markets had stabilized in February, although today’s hot inflation reading may re-introduce some of the volatility we saw in January.
Let’s look at recent history and briefly dive into the numbers so we may paint a picture. During the 2004 to 2006 rate-hike cycle, then-Fed Chairman Alan Greenspan said rate increases were likely to be “measured,” as he embarked on a series of quarter-point rate hikes.
His goal: Reassure investors and avoid rocking financial markets. His infamous “irrational exuberance” speech in 1996 did rock the markets.
Fed Chief Janet Yellen and later Powell also soothed anxieties by signaling rate hikes would be “gradual” when rates slowly began to increase in late 2015. “Gradual” wasn’t as opaque as “measured,” but the goal was the same: Reassure investors.
Greenspan and his successor Ben Bernanke raised the Fed funds rate from 1% to 5.25% in a predictable series of quarter-percent increases.
Yellen and Powell hiked the benchmark rate from 0%-0.25% to 2.25%-2.50% through an uneven series of quarter-point increases, or 25 basis points (bp). One bp = 0.01%.
Party Like It’s 1994
At Powell’s late-January news conference, he wasn’t making any promises on how quickly rates might rise. He wouldn’t rule out a rate hike at every meeting, beginning in March (there are eight scheduled meetings each year, including January). He didn’t dismiss the possibility of a 50bp increase. And, there was no mention of ‘gradual’ or ‘measured.’ When the markets sniff out uncertainty they tend to introduce volatility, which we saw in January.
The last time the Fed was truly aggressive was back in 1994, when the Fed implemented several 50bp increases and one 75bp hike. Rates doubled from 3% to 6% in one year.
During each of those tightening cycles, including 1994, inflation was under control. The Fed acted preemptively. Today, it is reacting to high inflation.
We are not saying we’re going to see a repeat of 1994. One key measure from the CME Group suggests five 25bp rate hikes this year. But it’s simply a projection. And projections can change based on how the economy progresses.
Powell warned that inflation could remain stubbornly high this year. Or, it’s possible supply chains will settle down and lessen the need for a strong central bank response.
The Fed’s challenge: Engineer a soft economic landing, which brings down inflation without throwing the economy into a recession.
Barring a significant health crisis or a major geopolitical event, the Fed’s new posture will probably be the focus this year.
Rate Hikes and Interest from Your Savings Account
Investors might think that rising interest rates would finally result in an increase in the interest rate they are receiving on their savings and other bank accounts. A recent Wall Street Journal article suggests that may not be the case.
Their claim is that banks have little incentive to raise the interest they pay on deposits because they simply don’t need the money. The Government stimulus pumped up American’s bank-account balances and banks are flush with cash. Even high yield savings rates have come down. Many banks that offered rates around 1.5% before rates headed towards zero in early 2020, now offer rates around 0.5%.
The article suggests that banks may change their tune and raise rates on their deposit accounts if investors move a chunk of their money into higher-yielding investments.