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Brett's Insights on the Federal Reserve interest rate and stock and bond market volatility May 2022 Thumbnail

Brett's Insights on the Federal Reserve interest rate and stock and bond market volatility May 2022

With last week’s Federal Reserve interest rate policy announcement and the ensuing stock and bond market volatility, I thought it would be good to discuss what this means to us as investors, as well as some historical perspective. 

The “Fed” laid out its course for interest rate increases over the remainder of the year, based on their current economic forecast (this can clearly change with the economy, but it helps us understand what it is thinking).  I have been asked why the “Fed” is raising interest rates when inflation is running at 40-year highs.  

 Let’s discuss what the “Fed” is trying to accomplish by raising interest rates.  First and foremost, the goal of increasing interest rates is to make the “cost” of borrowing more expensive for consumers.  A good example of this is housing; we have seen home prices skyrocket during Covid largely due to extremely low-interest rates.  Before the “Fed” even raised interest rates this past week, mortgage rates had almost doubled this year.  This will have the effect of slowing home demand and price increases.  And this will have a ripple effect on the economy as all consumer loans will become more expensive including commercial and industrial loans.  If we remember from our high school economics class, inflation is caused when there is more demand for goods and services than there is supply.  

Remembering back to the 4th quarter of 2019 and the spread of Covid, we saw the first signs of supply disruptions in China; we began to experience shortages of all types of imported goods.  This was followed by shutting down the economy, dropping interest rates to near zero, sending checks to American citizens and businesses.  Most Americans were still employed during this time and were working from home, so they had time and money.  Americans discovered the joy of online shopping…and shop they did.   

I hate to call this the perfect storm, but we’ve had every ingredient needed for run-away inflation; increased demand, increased money supply, increased government spending, global supply chain issues, then the Russian invasion of Ukraine with the sanctions that followed.  

It is critical that the “Fed” act now to try and bring inflation back to a more normal range before it gets out of hand (you may remember the 1970s and early 1980s).  Inflation is a tax on everyone, impacting lower-income families the most, and once it gets ingrained into an economy, it's difficult to break the cycle.   

Through yesterday, U.S. equity markets were down about 20% from the highs reached in December 2021(measured by the S&P 500).  To put this in perspective, the last time the “Fed” was in a cycle of interest rate increases was 2016-2018, when the “Fed” raised rates 9 different times over a three-year period.  This ended with equity markets down by almost 20%. If we go back to the stock market highs in 2018, before the market drop, we are still up almost 40% during this time period (which includes a 20% drop in 2018, 34% drop in 2020, and now a 20% drop).   

We must manage our emotions at times like these, knowing that if we stick with our plan, markets will recover.  Two weeks ago, at the Berkshire Hathaway annual meeting, Warren Buffett (now age 91), commented that “Berkshires success is more about being sane than smart”.  I thought that was a very modest comment coming from the greatest investor of our time.  He also went on to disclose that Berkshire has spent over $50 billion buying stock in great American businesses over the last several weeks while many investors are selling.  Situations like these, he said, “always creates opportunities for Berkshire”.   

I’ve rattled on too long now, so to sum things up, we must manage our behavior during times like these and focus on our plan.  These events happen more often than we would like, and they are not that different from events in the past.   

On a personal note, these past two and a half years have been the most volatile years I can remember during my adult lifetime, not just in the markets.  I know many of us are just feeling fatigued.  I mentioned during the lockdowns how important it is to take care of ourselves and one another during periods like this; It hasn’t changed.  I can see and hear stress in conversations I am having with many people.  Take special care of yourself and your loved ones.   

Warmest regards, 

Brett S Carleton, CFP, ChFC