As a California resident, this year I’ve witnessed gas prices rise as high as $7.00/gallon, along with staggering increases in rent and groceries. Believe me when I say shrinkflation is a real concept. Some essentials are scarce or not even on the shelves. As an investor, this year has been incredibly volatile, with some of my favorite stocks taking a tough beating. Inflation has certainly done a number on us. The Federal Reserve’s attempt to stimulate the economy after the global pandemic certainly has its effects.
Inflation can occur when there is a rise in consumer demand but a shortage of supply. During the pandemic, trillions of dollars were pumped into the economy which provided additional purchasing power for consumers. This sudden influx of money consequently drove consumer prices up. In turn, the US and international supply chains were strained, just as consumer demand rose. The Russian invasion of Ukraine also caused a disruption in oil prices, manufacturing, and shipping. These factors gave rise to the inflation we are experiencing today. Some corporations and landlords see inflation in the headlines and have sought opportunities to not only keep up with it but also try to profit from it.
The U.S. Federal Reserve Bank’s (aka the Fed) primary goal is to uphold the dual mandate of keeping inflation in check and unemployment low. But inflation rates and employment rates tend to have an inverse relationship. When the unemployment rate is low, the economy is stimulated as consumers have more money to purchase goods which causes prices to rise. It is a difficult balancing act. The Fed’s monetary policy can either be described as “hawkish” or “dovish”. The Fed is “dovish” when striving to sustain employment and “hawkish” when striving to manage inflation. With the inflation rate at a 40-year high, the Federal Reserve has implemented the most aggressive hawkish measures we have witnessed in decades. This year, the Federal Reserve has raised the federal funds rate six times. In just six short months, the rate jumped from 0% in March to 3.75-4%. The staggering four consecutive hikes of 75 basis points, have many consumers on the edge of their seats and bracing themselves for the long-awaited recession.
Some critics tend to perceive hawkish measures of the Fed as negative or even malicious. But it helps to think about what a hawk symbolizes – strength, determination, and most importantly, protection. The Fed is the hawk attempting to slow down inflation because high inflation is a greater threat right now than slightly higher unemployment. The Fed is focused on avoiding hyperinflation, even if it means raising rates too fast in the meantime. Hyperinflation could cause even more detrimental effects and trigger a depression which would take longer to recover from than a mild recession.
The well-known investing mantra, “Don’t Fight the Fed”, is a phrase that was coined by Martin Zweig in his book, Winning on Wall Street. He explains how the stock market reacts to the Federal Reserve’s monetary policy decisions and suggests that you align your investment decisions with those of the Federal Reserve. The advisory team at Regatta surely agrees with his mantra and works tirelessly to find solutions that are in alignment with the Fed’s decisions. Zweig pointed out the risk of making investment decisions contrary to the Fed. Going against the Fed raising rates today would look like a risk-averse short-term investor choosing to invest heavily in tech equities, which we all know are not doing so great right now, rather than assets that preserve capital. Another example of fighting the Fed would be if a financial advisor told my grandmother in the last few years, “the rule of thumb is to own high-quality long-term bonds in the percentage that equals your age”. The Fed lowered bond rates to such low rates during the pandemic that these traditionally “safe” assets represented a lot of risks. If my grandmother followed this advice, her long-term government bonds would be down 20% this year.
The Federal Reserve will likely raise rates again in their final meeting of the year in December by at least 50 basis points and once more in January 2023. While borrowing costs may be high, there is an even stronger incentive to save. The advantage of a “hawkish” Fed for investors is you can find more attractive money market rates and bond rates. The money market rates are competitive with returns at 3.25%, but ultra-short corporate bonds and longer-term municipal bonds look even better for longer-term savers. So, don’t fight the fed. If there was any time to have a trusted Financial Advisor, now is that time!