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Tag: interest rates

A Tricky Recipe

You’ve probably noticed the volatility wreaking havoc in the markets over the past few weeks. To understand what’s going on, let us tell you a story.

Imagine you are inside a fancy restaurant, waiting for your meal to be prepared. While you wait, you can watch the chefs as they work. Suddenly, though, you notice there seems to be some uncertainty going on in the kitchen. By listening closely, you can just barely make out what the chefs are arguing about: Does the recipe call for two teaspoons of salt, or two tablespoons? Or is it even two cups?

One by one, the other diners start paying attention to the debate, too. Each voices their opinion to the other. Some diners want the chefs to add two teaspoons of salt. They rationalize that, while you can always add more salt later, but you can’t ever un-salt your food. Too much salt will ruin both the meal and everyone’s night. Others point out that there are no salt shakers on the tables, meaning if more salt is needed, the chefs will have to do it themselves. That will delay the meal, and people need to eat now. Better to just use two tablespoons. Sure, maybe the food will end up a little too salty, but that’s better than overly bland food — or no food at all.

As the wait drags on, the diners start getting nervous. They decide to amend their order and ask for less food. Other diners decide to leave the restaurant entirely. Finally, the head chef announces the restaurant is committed to adding just the right amount of salt, so they will add it gradually, little by little, until they know they have it right.

Unfortunately, this little speech, while providing clarity as to the chef’s intentions, does nothing to quell the concerns of all the diners. Some applaud loudly, others boo. Some rush to order more food, while others ask for the check. Before long, the noise is deafening.

Maybe, you think, we should have just ordered a pizza.

Crazy as it may seem, this little play actually describes some of what’s going on in the markets right now. (Except that the chefs are the Federal Reserve, the food is the economy, the recipe is for bringing down inflation, and the salt is interest rates.)

For the last nine months, the Federal Reserve has been trying to follow an incredibly tricky recipe: Bring down inflation without bringing down the economy. Just as chefs use salt to flavor food, our nation’s central bank uses interest rates to help moderate runaway consumer prices. The problem both face is it can be difficult to know how much of that magical ingredient to use. Just as too much salt can make food unbearable to eat, raising interest rates too high, too fast can trigger a recession. Raising interest rates too little, however, might do nothing to quell inflation. And like those diners in the story who needed to eat, consumers need relief from inflation now.

Those diners, of course, are investors. Every investor has their own opinion on what the Fed should do. More importantly, every investor is trying to guess what the Fed will do. That guessing is the prime reason for all this volatility. Investors who believe rising interest rates will hurt corporate earnings and trigger a recession decide to eat somewhere else, bringing the stock market down. Investors who still see the restaurant as the best place in town – regardless of interest rates – order more food and drive the markets back up.

Remember in the story how the head chef came out and made a big speech? Well, that’s my attempt at describing what Fed Chairman Jerome Powell did two weeks ago. Every year, Powell delivers a speech in Jackson Hole, Wyoming where he reveals the Fed’s views on the economy. In the days leading up to his speech, some investors thought he might announce the Fed would look to dial back on hiking rates much further. Their reasoning? Some data suggests inflation is peaking, so there’s no need to keep raising interest rates.

Powell wasted no time in dashing those hopes, however. In his speech, Powell said that this is “no place to stop or pause.”1 Fighting inflation will remain the Fed’s number one priority for the foreseeable future. That means the Fed will continue to gradually raise interest rates, likely around 0.5% to 0.75% every few months. He further said:

“While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.” 1

In other words, bringing down inflation is simply more important than stimulating economic growth right now. (Or propping up the markets.)

This is why there’s been so much volatility in the markets lately. It’s also why we can expect volatility to continue, at least in the short-term. Many economists expect the Fed to hike rates by another 0.75% later this month. So, don’t be surprised to see more volatility before and after that announcement, if it comes.

The reason we’re telling you all this is to assure you that, while volatility is never fun, it is not unexpected. It has not taken us unawares. Nor, frankly, do we feel it’s something you need to stress over. You see, here at Minich MacGregor Wealth Management, we act more like “financial dietitians” than anything else. (This is the last food metaphor, we promise.) A dietitian focuses on using the fundamentals of good nutrition to help people eat better, healthier foods so they can achieve their health goals – regardless of what’s “in style” or what celebrity fad-diet is trending. As your financial advisors, our job is to help you achieve your financial goals, in part by making sound, long-term decisions, not overreacting to what the Fed does – or says – or what the market thinks about it.

To put it simply, the volatility we’ve seen lately is the same old story we’ve been reading about all year long. It’s the same story we’ll probably continue to read about moving forward. For that reason, our advice is to enjoy the end of summer rather than stressing about market headlines. Our team will continue to monitor your portfolio. And of course, if you ever have any questions or concerns, please let us know. That’s what we’re here for!

1 “Powell warns of ‘some pain’ ahead as the Fed fights to bring down inflation,” CNBC, August 26, 2022.  https://www.cnbc.com/2022/08/26/powell-warns-of-some-pain-ahead-as-fed-fights-to-lower-inflation.html

Bear Market Update

The S&P 500 has recently slid into a bear market due to inflation and fears of a recession. As expected, the Fed announced a 0.75% interest rate hike.1  That may not sound like much, but it’s the largest single rate increase since 1994. 1  To keep you up to date on what’s going on, let’s do a quick Q&A. 

Q: What, exactly, did the Federal Reserve do?

A: Raise the “Federal Funds Rate”.  This is the interest rate that banks pay each other for overnight loans.  When the rate goes up, it costs more for banks to loan each other money. In response, banks raise their own interest rates. That’s why, when the Federal Reserve raises the federal funds rate, it eventually affects consumers and small businesses whenever they apply for a loan.  Specifically, the Fed raised the rate up 0.75% to approximately 1.6%.1 

Q: How did the markets react?

A: Initially, the markets rose soon after the announcement, as it was expected, and because many experts believe it’s necessary to tamp down on inflation.

The day after, though, the markets continued their slide.  The S&P 500 and NASDAQ are firmly in bear market territory, and the Dow is getting close. 

The reason for this is because the Fed also announced that a second 0.75% rate increase is possible in July.  While higher interest rates are a proven tool for fighting inflation, each rate hike increases the odds of a recession, even if it’s a small one.  The markets dropping further is essentially investors pricing in the likelihood of more action from the Fed…and a greater chance of an economic downturn. 

Q: What is the Fed hoping to achieve here?

A: When the Fed announced the rate hike on Wednesday, they also revealed something else: Their economic outlook for the rest of 2022.  The Fed’s hope is to achieve what’s called a “soft landing.”    This is where economic growth slows, but a full-blown recession is avoided.  There’s some justification for this hope.  After all, if you remove inflation from the equation, the economy is actually in pretty good shape.  The unemployment rate is at 3.6%, which is almost back to where we were in January 2020 before COVID hit.2  And consumer spending – the bedrock of our economy – remains strong.  It was to shore up the economy that the Fed dropped interest rates in the first place.  Now, the thinking goes, that mission is complete, which means it’s time for the Fed to pivot to the second prong of their “dual mandate”: stabilizing prices.  (The first prong is stable employment.)

Unfortunately, soft landings are historically difficult to achieve, and the most recent data suggests an economic slowdown may already be happening.  Consumer sentiment is dropping, retail sales numbers have dropped slightly over the last month, and while the economy continues to add jobs, it did so at a slower pace in May.1  Even the Fed admits that the unemployment rate will likely go up over the next few years.  (Moving from 3.6% to 4.1%, according to their projections.1

Q: So, what should we do moving forward?

A: The main thing right now is to remember that the markets move based on what investors expect to happen, not what is happening right now.  At any point, those expectations could change.  Every new bit of economic data between now and the Fed’s next meeting in July will be carefully scrutinized.  That’s why it’s never a good idea to overreact to the day-to-day swings in the market, even if they seem significant.  The sentiment that drives the market today may be completely different tomorrow. 

Remember: We endured both a bear market and a recession not very long ago.  Keeping the long-term in view helped us not only get through rough times but take advantage of a tremendous recovery. 

Of course, if you have any immediate financial goals, or need access to some of your money in the short-term, let us know and our team will help you promptly.  And of course, if you have any questions or concerns about your portfolio, don’t hesitate to reach out.  That’s what we’re here for!     

As the summer progresses, we’ll keep you apprised about what’s going on in the markets.  In the meantime, enjoy the warmer weather knowing that we are here to do everything we can to keep you working toward your financial goals.      

1 “Fed hikes its benchmark interest rate by 0.75 percentage point, the biggest increase since 1994,” CNBC, https://clicktime.cloud.postoffice.net/clicktime.php?U=https%3A%2F%2Fwww.cnbc.com%2F2022%2F06%2F15%2Ffed-hikes-its-benchmark-interest-rate-by-three-quarters-of-a-point-the-biggest-increase-since-1994.html&E=maryellen%40mmwealth.com&X=XID793AFuR7T7793Xd2&T=MMWL&HV=U,E,X,T&H=46cf2e46f2cc5f68e79a2d364fd4ec5052f5340f

2 “The Employment Situation – May 2022,” Bureau of Labor Statistics, https://clicktime.cloud.postoffice.net/clicktime.php?U=https%3A%2F%2Fwww.bls.gov%2Fnews.release%2Fpdf%2Fempsit.pdf&E=maryellen%40mmwealth.com&X=XID793AFuR7T7793Xd2&T=MMWL&HV=U,E,X,T&H=0c145dfe397266fae066dd051f8fdcdbef3da5e2

Storms ahead? What you need to know

The stock market got a little crazy this week.

Is a storm coming?

Let’s take a look at what’s driving markets right now.

(Scroll to the end if you just want our takeaways.)

A few things are driving the market volatility:

Fears of a financial crisis in China.

China’s overheated real estate bubble is starting to pop and Evergrande, a giant Chinese property developer, is heading toward defaulting on more than $300 billion in debt.1

Its failure could trigger a cascade of defaults among banks, materials suppliers, and investors, potentially leading to broader financial issues in China and abroad.

Worries the Federal Reserve will start tapering soon.

The Fed meets this month and traders are uneasy about the idea that the central bank could start pulling back the support now that inflation is higher and the jobs market has improved.2 Firms that depend on low interest rates and easy credit could be hurt.

Concerns about COVID-19 case numbers.

Variants continue to pop up and the delta variant continues to keep cases and hospitalizations high. Investors are concerned that another winter resurgence (like we saw last year) could slow down business and economic activity.3

Fears of another debt ceiling showdown.

Once an ordinary part of federal accounting, adjusting the debt ceiling is now a political negotiation, threatening the Treasury Department’s ability to pay its bills next month.

Though it’s unlikely either party will allow the U.S. to default on its obligations, this political brinksmanship adds anxiety each time it comes up. Another government shutdown could exacerbate political risks to markets.4

Do you see a trend? Markets are being driven by fear, anxiety, and doubt.

Which of these squalls will fade away and which could blow into a tempest?

We can’t know.

So, here’s the real question:

Could we see a 10%+ correction in the weeks or months ahead?

Possibly.

Corrections and pullbacks happen regularly and it wouldn’t be surprising to see a market drop.

To show you just how ordinary corrections are, here’s a chart that shows intra-year dips in the S&P 500 alongside annual performance.

(Take a look at the red circles to see the market drops each year.)

The big takeaway? In 14 of the last 20 years, markets have dropped at least 10%.5

Even years with strong performance saw big drops.

We’re dealing with a lot of uncertainty and investors are feeling understandably cautious about what’s ahead.

But, that doesn’t mean that we should panic and rush for the exits.

Pullbacks, corrections, and even downturns don’t last forever.

Trust the process. Trust the strategy.

We’re keeping an eye on the Chinese property market situation, as well as workings over in Washington. We can’t predict which way markets will go in the coming weeks, but we’ll be in touch as needed.

Have questions? Feeling uneasy? Please reach out. That’s what we’re here for.


1https://www.cnbc.com/2021/09/17/china-developer-evergrande-debt-crisis-bond-default-and-investor-risks.html

2https://www.nbcnews.com/business/markets/dow-futures-tumble-more-600-points-september-slide-intensifies-n1279618

3https://www.cnbc.com/2021/09/19/stock-market-futures-open-to-close-news.html

4https://www.nytimes.com/2021/09/20/business/stock-market-federal-reserve.html

5https://am.jpmorgan.com/content/dam/jpm-am-aem/global/en/insights/market-insights/guide-to-the-markets/mi-guide-to-the-markets-us.pdf

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax professional.

Taper tantrum part deux?

How are you doing?

Are you making plans for fall or taking a step back to reassess?

One big thing you may have heard about in the headlines is the Federal Reserve’s hint that it might start “tapering” soon.1

Could the Fed’s actions cause a correction or economic slowdown?

Let’s discuss.

First of all, what does ”tapering” mean?

In econ-speak, tapering means winding down the pace of the assets Fed has been buying since last summer.

Why is it a big deal?

Well, the last time the Fed tapered in 2013, during the recovery from the 2008 financial crisis, markets panicked and pitched a “taper tantrum.”2

That’s because traders worried that less Fed support would hurt fundamentals and potentially cause a market downturn.

Now, that old taper tantrum narrative is making folks worry that another market downturn could be ahead of us, especially with concerns about the delta variant.

Before we dive into what could happen, let’s talk about where we are and how we got here.

When the pandemic started, the Fed slashed interest rates and began buying $120 billion a month in bonds and mortgage-backed securities to reduce interest rates, lower borrowing costs, and give businesses and the economy a boost.1

However, now that the economy is much stronger, the employment situation has improved, and inflation is a concern, the Fed wants to start paring back those asset purchases to return interest rates to a more “natural” level.

What could that look like?

Obviously, we don’t know exactly when or how the Fed will decide to act, but analysts have some pretty good guesses.

The latest prediction by Bank of America suggests tapering could start this November as the Fed gradually pares back asset purchases through next year.1

The takeaway is that the Fed isn’t going to stop buying assets and raise interest rates immediately.

It’s going to gradually remove the support and see how the economy reacts.

So, will we see another taper correction?

The main reason folks worry about Fed reducing support is because of the effect higher interest rates could have on stocks, particularly companies that rely on borrowed money.

However, interest rates are just one piece of the puzzle. Economic fundamentals, earnings, and other factors also weigh on stock prices.

With the benefit of hindsight, we can see that the 2013 taper tantrum wasn’t even that bad. The S&P 500 tumbled 5.8% over the course of a month but quickly recovered (the caveat here is always this: the past does not predict the future).2

We think the main reason markets declined last time was that investors hadn’t experienced tapering before; they didn’t have context for what the Fed would do.

Since we’ve seen this happen before fairly recently, we think that uncertainty is lessened.

However, we also have other worries to consider: a deteriorating crisis in Afghanistan, continued pandemic worries, and political wrangling over infrastructure.

Any of these factors could derail the bull market.

But it’s not going to be the end of the world.

Corrections are always something we should expect. They happen regularly and are a natural part of markets.

The Fed is one more thing we’re keeping an eye on, and we’ll reach out if there’s more you should know.


1 https://markets.businessinsider.com/news/bonds/fed-taper-asset-purchases-november-bonds-mbs-federal-reserve-economy-2021-8

2 https://www.barrons.com/articles/stock-market-taper-scare-what-comes-next-51629505091