The Federal Reserve’s Ice Bucket Challenge…
Remember a few years ago when people raised money for charity by challenging others to pour buckets of icy water over their heads? Last week, the Federal Reserve poured a bucket of ice water over the United States stock market. Randall W. Forsyth of Barron’s explained:
“In the past week, Fed officials stepped up their rhetorical anti-inflation campaign, with Jerome Powell all but promising a half-point increase in the federal-funds target range at the next Federal Open Market Committee meeting, on May 3-4. And other Fed district presidents raised the possibility of more forceful action, including rate hikes of as much as three-quarters of a percentage point, something the Fed hasn’t done since 1994.”
The Fed’s goal is to slow high inflation, which has been exacerbated by the war in Ukraine and China’s coronavirus lockdowns, without pushing the American economy into a recession. The question is whether the economy is strong enough to continue to grow as the Fed tightens monetary policy – and opinions about that vary.
One participant in Barron’s Big Money Poll, which surveys institutional investors across the U.S., wrote, “It’s not as bad as people think…Yes, interest rates will rise, but earnings will also rise along with that. Profit margins continue to be very high, and employment is strong. It’s growth slowing down, not ending.”
Another participant disagreed, reported Nicholas Jasinski of Barron’s. “[The Fed] should have started the process of raising rates sooner so they could be more patient with the pace of increases…Now, they are going to be overly aggressive trying to play catch-up, and will probably go too far and slow demand down too much.”
Last week, major U.S. stock indices declined, reported William Watts and Barbara Kollmeyer of MarketWatch, and the real yield* for 10-year U.S. Treasuries was briefly in positive territory for the first time since the pandemic began in 2020, reported Jacob Sonenshine of Barron’s.
*When the term “real” is used with interest rates, it means the rate has been adjusted for inflation (the bond yield minus inflation). So, the real return is what investors would have after inflation.
Here’s a riddle: How can inflation be 8.5 percent and 6.5 percent at the same time? The answer is that it depends on how you measure it.
Determining how quickly prices are rising or falling – and where they may be headed in the future – is not simple. In the United States, millions of goods and services are bought and sold every day – shelter, food, transportation, energy, water, education, childcare, equipment and tools, medical care, furnishings, apparel, trash removal, and much more.
The government relies on two indexes: the Consumer Price index (CPI) and the Personal Consumption Expenditures Index (PCE). Each index has two versions: headline inflation and core inflation.
Last week, the Bureau of Labor Statistics (BLS) reported that CPI headline inflation was up 8.5 percent in March, and CPI core inflation was up 6.5 percent.
The BLS does not collect every price in every part of the United States. It gathers prices in 75 cities, collecting data from about 6,000 households and 22,000 department stores, supermarkets, hospitals, gas stations, and other establishments. So, the CPI is a measurement that reflects the experience of urban consumers.
CPI headline inflation
Last week, the CPI showed that headline inflation, which includes all price changes collected, was up 1.2 percent from February to March, and up 8.5 percent for the 12-month period that ended March 31. The largest increases in the CPI were:
CPI core inflation
The BLS also reported on core inflation, which is the CPI minus food and energy prices, and was lower than headline inflation. The core CPI was up 0.3 percent from February to March, and up 6.5 percent for the 12-month period that ended March 31.
Why would anyone want to exclude staples like food and energy from inflation?
The answer is that food and energy prices are volatile – food and energy are commodities that trade on exchanges – and can distort inflation readings. “Trying to manage monetary policy with gauges that fluctuate wildly would be like driving a car where the speedometer was constantly fluttering between 30 mph and 60 mph. Taking a long-term average may reduce the effect — but only for looking at the past history. Policymakers are forward-focused. They need guidance on where the inflation trend is headed. High volatility obscures that trend,” explained George Calhoun of Forbes.”
To sum up: headline CPI reflects Americans’ cost increases in the recent past, while core CPI is a better indicator of where inflation may be headed, reported Joseph Haubrich of the Cleveland Federal Reserve.
It’s important to note that the Federal Reserve relies on the PCE when making policy decisions. The PCE is a broader measure of inflation than the CPI. The PCE includes measurements taken in urban, non-urban, and rural areas, as well as spending by members of the military and a wider range of organizations. PCE data for March will be released on April 29.
Last week, major U.S. stock indices declined, reported Al Root of Barron’s. The yield on 10-year Treasury notes rose last week.
Guidance Wealth will be closed Friday, April 15th to observe the Good Friday holiday
The first quarter of 2022 was jam-packed with volatility-inducing events: rising inflation, war in Ukraine, rising interest rates, sanctions on Russia, and a new COVID-19 outbreak in China.
Here’s a brief review of what happened during:
Inflation continued to rise. At the start of the year, consumers and investors were primarily concerned about inflation. In February, the Personal Consumption Expenditures Price Index showed core inflation, which excludes volatile food and energy prices, was up 5.4 percent year-over-year. That’s well above the Federal Reserve (Fed)’s two percent target for inflation.
The Fed began to tighten monetary policy late in 2021 by curtailing its bond-buying program. Investors expected the Fed to continue fighting inflation in 2022 by raising the federal funds target rate. Raising rates makes borrowing more expensive, which causes consumer and business spending to slow, demand for goods and services to drop, and prices to move lower, reported Carmen Reinicke of CNBC.
Russia invaded Ukraine and sanctions followed. In late February, Russia shocked the world by invading Ukraine. The war has devastated the people and the economy of Ukraine. The Kyiv School of Economics estimated that physical damage inflicted on Ukraine’s roads, bridges, rails, ports, residences, factories, airports, hospitals, and schools from February 24 to April 1 exceeded $68 billion, reported The Economist. As the human and economic costs of the war filtered through markets:
Higher energy prices exacerbated global inflation. For example, rising fuel prices lifted other prices, too. The cost of diesel fuel, which is primarily used for trucking and shipping, rose 63 percent in the United States during the first quarter. Higher transportation and delivery costs were reflected in the cost of other goods, including food, reported Brian Swint of Barron’s.
Central banks continued to tighten monetary policy. The war in Ukraine complicated the outlook for economic growth and inflation around the world. Despite uncertainty about growth, many central banks tightened monetary policy to bring inflation down.
In the U.S., the Fed raised the federal funds target rate by 0.25 percent in March. Fed officials expect to raise rates six more times in 2022 and begin reducing the Fed’s balance sheet, a process known as quantitative tightening, at its May meeting.
Yields on U.S. Treasury notes and bonds shifted higher during the quarter and into April. The yield on the 2-year Treasury note rose from 0.78 percent at the start of the year to 2.53 percent at the end of last week, while the benchmark 10-year Treasury yield rose from 1.63 percent to 2.72 percent. When bond yields rise, bond prices fall. In the first quarter, Morningstar indices for U.S. Treasuries, corporate, high-yield, and mortgage bonds all moved lower.
A new COVID-19 outbreak in China led to a lockdown in Shanghai. On March 28, Shanghai, China, a city of 25 million people, was locked down amid a new COVID-19 outbreak. A source cited by Reshma Kapadia of Barron’s stated:
“…concern is growing about the scars it may leave on Chinese consumers—a crucial growth engine for the struggling economy but also for a host of global companies…Consumers will be more cautious this time around. Their pandemic savings are depleting, wealth has been destroyed in equities and property and wage growth has already turned down.’”
The Shanghai Composite Index dropped by almost 10 percent during the quarter, reported Reuters.
Overall, stock markets declined during the first quarter of 2022. The MSCI All Country World Index (ACWI) measures the performance of mid-sized and large company stocks in 23 developed markets and 24 emerging markets. It reflects the performance of about 85 percent of the investable stocks across the world and finished the first quarter of 2022 -5.36 percent.
There were some regions that delivered positive returns during the period. For example, markets in some commodity-exporting countries in Latin America, Africa, and the Middle East benefitted from the supply disruptions that followed Russia’s invasion of Ukraine.
We anticipate that markets will remain volatile in the coming weeks and, possibly, months. We will continue to monitor events around the world and the ways in which they may affect markets and asset prices and we hope peace talks will conclude the war in Ukraine.
Guidance Wealth will be closed Friday, April 15th to observe the Good Friday holiday
Checking in on the Federal Reserve.
Among other things, Congress asks the Federal Reserve to use its tools to promote price stability and maximum employment. Last week, economic data provided information about both.
Inflation continued to increase
Price stability means ensuring the prices of goods and services increase at a slow and stable pace. Last week, the Bureau of Economic Analysis reported that consumer prices rose 5.4 percent, year-over-year in February, excluding food and energy. When food and energy were included, inflation increased 6.4 percent.
Personal income increased, too, but not quite as quickly as inflation did.
The Fed’s target for inflation is 2 percent. To bring inflation into line, the Fed has begun tightening monetary policy. So far, it has ended asset purchases and started raising the federal funds target rate. Next, it will begin to shrink its balance sheet. However, the war in Ukraine and a new COVID-19 outbreak in China are complicating the Fed’s inflation calculations.
Unemployment remained low
Maximum employment is “…the highest level of employment the economy can sustain without generating unwelcome inflation It describes an economy in which nearly everyone who wants to work has a job, reported Lorena Hernandez Barcena and David Wessel of Brookings.”
Not everyone who wants a job has one, but last week’s employment report from the Bureau of Labor Statistics showed the unemployment rate was quite low at 3.6 percent, overall. When the statistic is viewed by gender and race:
Major stock indices finished the week mixed, reported Ben Levisohn of Barron’s. The Treasury yield curve inverted last week with the yield for a 10-year Treasury dropping below the yield for a 2-year Treasury.