The Outcome of the Much-Anticipated Fed Symposium
Every August the Federal Reserve Bank of Kansas City hosts the Jackson Hole Economic Symposium and every time this meeting is held, the market pays attention to everything that is said or implied. This year was no different, analyst watched closely to what Fed Chair Powell had to say about inflation, unemployment and their current bond purchasing program.
The Federal Open Market Committee has two objectives: full employment and price stability. It is a challenging task. In order to accomplish that goal, they control short interest rates, and as of the last decade, long interest rates. As interest rates move up and down, it affects the economy and the stock markets. When rates are lower, people and businesses are incentivized to borrow money to spend; however, the opposite is true.
As a result of the Great Recession, the Federal Reserve lowered short-term interest rates to practically zero, but it still needed more fuel to help the economy. That is when it embarked on its bond purchasing program, called quantitative easing (QE). Before the financial crisis, the Fed balance sheet was under $1T, but as a result of QE, the balance sheet ballooned to about $4.5T. Once the economy was stable, the Fed then went on a path to unwind the bond buying program, but then COVID happened. In an effort to support the economy, the Fed expanded their balance sheet to where it is today at about $8.3T.
Now that the economy appears to be stable once again, it does not need the Fed’s bond buying program to keep things moving forward. Their unwinding of the program is what we call tapering. The markets have been paying close attention because when they stop buying long-term bonds, long-term yields are expected to increase. The 10-Year US Treasury Bond is considered the risk-free rate and the starting point for equity valuations. If the yield increases, then the expected future cashflows of corporations are discounted at a higher rate, which leads to a lower present value and translates to lower stock prices. This is why the markets care so much about the start and magnitude of when the Fed plans to taper.
Coming back to Fed Chair Powell’s comments today, he said that there is an agreement among the Fed Presidents that the economy is now on a good path, and they are likely to begin to taper before the year end. [i] For the most part, the markets had anticipated those comments, so we did not see a selloff in stocks as of Friday early afternoon. In fact, the markets rallied with the S&P 500 up almost 1%. The reason stocks were up is that the Fed said there is still much ground to cover before it plans to raise short-term interest rates and that it will continue its overall accommodative stance.
On the inflation front, the Fed continues to hold its view that inflation is transitory. This was a big debate earlier this year and our own data confirmed the Fed’s view. Today, most analysts now are seeing that inflation is unlikely to persist and that the Fed is likely to be correct.
As for our investment strategy, part of our portfolio is invested in growth stocks, and unlike many money managers, we did not abandon our holdings in fear of inflation. In fact, we were looking for opportunities to buy on big selloffs because we knew these stocks were getting beat up on inflation fears that our data showed was unwarranted.
The Surevest Investment Committee is data dependent and as we get more information, we will reevaluate if any shifts are needed and make the appropriate modifications to our portfolios. We will keep you up to date on our weekly Market Updates.