Rate Concerns Weigh On Stocks
Investor hoped that a continued cooling in inflation might support a more dovish Fed.
But that optimism faded as a surprising rise in producer prices and another decline in initial jobless claims triggered worries the Fed would stay the course for longer.
Comments from two Fed officials supporting a more aggressive rate hike stance added to the unease, erasing much of the week’s gains.
Inflation Moderation Pauses
Consumer prices climbed 0.5% in January, fueled by rising shelter costs and energy prices. The year-over-year inflation number (6.4%) came in lower than December’s 12-month rise of 6.5%, making it the seventh consecutive month of declining year-over-year inflation.
Stocks Resume Climb
After rebounding to start the week, stocks weakened following higher inflation numbers out of Europe and higher-than-expected manufacturing activity.
Stocks continued their decline into early Thursday following a report of higher labor costs and low initial jobless claims. But stocks staged an afternoon relief rally on Thursday following comments by Atlanta Fed President Raphael Bostic that he was “still very firmly” supportive of increasing rates in quarter-point increments. The climb in stocks was remarkable, given that yields on 10-year Treasuries reached their highest level since November. Undeterred by a strong services data report, the upside momentum continued into the final trading day and added to the week’s gains.1
Disconcerting Economic Data
It was a relatively quiet week for economic news, but several new economic data reports gave insights into overall activity. U.S. manufacturing activity contracted in February–the fourth consecutive month it has done so. While this may eventually justify a reason for moderating future rate hikes, the activity exceeded analysts’ expectations. An accompanying survey of manufacturers pointed to improving demand and potentially accelerating price pressures.
Meanwhile, China reported an outsized jump in manufacturing activity, which may help relieve remaining supply chain kinks. But the report may also fuel commodity price increases and influence global inflation. Inflation remained a persistent issue in Europe, as February’s Eurozone inflation read was hotter than anticipated.
Inflation, Rates, and Recessions
In the fight against inflation, the Federal Reserve aims to achieve a "soft landing." This means the economy cools down just enough but not so much that it enters a recession. There is skepticism, even from the Fed Chair himself, Jerome Powell, that the central bank will be able to pull this off. However, Powell believes a soft landing is still possible. He points to the history of soft and hard landings to explain the Fed’s current inflation-fighting strategy.2
How Does the Fed Control Inflation?
The Fed seeks to keep the U.S. economy healthy and stable through a dual mandate:
1) targeting stable prices—a core inflation rate averaging 2% over the long term
2) maximizing employment.
In December 2022, the annual headline inflation rate (CPI), was 6.5%.3 Although inflation has fallen from a peak of 9% in June—the highest levels since the 1980s—its current level remains out of line with the Fed’s mandate. Therefore, policymakers continue to maintain a tight monetary policy.
The Fed’s primary means of tightening is called monetary policy and is implemented by increasing the federal funds rate. This is the rate banks charge each other for overnight loans. As we spoke about in our last Market Update video, the Fed has raised rates at a pace unseen in the past.
How do increases in the federal funds rate transmit through the economy? It tends to slow down economic activity by decreasing the money supply, i.e., the amount of money in circulation in the U.S.
An analogy we like to give - as water cools down, the molecules that make it up start to move slower and slower until it freezes. Likewise, the Fed is hoping to reduce the "temperature" of the economy and slow things down - but hopes to avoid a deep freeze.
When borrowing costs rise, banks require their customers to pay more for loans. Therefore, Fed rate increases indirectly affect all consumer loans, including mortgages.
Here is a simplistic view of how interest rate increases aim to reduce economic activity and decrease inflation.
INCREASE
- Interest Rates
in order to
DECREASE
Lending
Money Supply
Spending
Demand for Goods and Services
Prices
Inflation
Soft Landings vs. Hard Landings
While policymakers hope their efforts will generate a soft landing, sometimes they overshoot, resulting in a hard landing.
A soft landing occurs when the Fed restores its dual mandate without triggering a recession.
A hard landing occurs when monetary policy reins in economic activity too much or fails to control inflation, leading to a recession and/or high unemployment.
The Fed has a lot to think about when tightening monetary policy to reduce inflation:
Interest rate increases affect other areas, such as asset prices, markets and exchange rates, which may in themselves bring adverse effects.
Consumers’ expectations of inflation may contribute to inflation becoming entrenched—or sticky—and more challenging to reverse with monetary policy.
There is a time lag between the implementation of policy changes and when the economy feels the effects of those changes.
As a result, the Fed holds meetings throughout the year to determine its next move, raising interest rates in steps. It also looks to lessons learned from its past actions as a guide for addressing current challenges.
History Shows a Mixed Bag of Soft and Hard Landings
The Fed is currently engaged in its 12th episode of tightening economic policy since the 1960s. How did it fare in the last 11 cycles?
Inflation and Interest Rates History Since 1965
Source: Bloomberg. Data from 1/31/1965 to 12/31/2022.
Policymakers today want to avoid repeating the 1970s, when high inflation became entrenched. The Fed sporadically raised interest rates in an attempt to break inflation and then quickly cut rates when it thought the economy slowed too much and in some cases fell into a recession.
Now after treating inflation as “transitory” through early 2022, the Fed is making up for lost time with bold rate increases in hopes of influencing expectations.
Tax Season Reminder
Generally, distributions from a traditional Individual Retirement Account are taxable in the year the account owner receives them. But, a qualified charitable distribution (QCD) is one exception to this rule.
A QCD is a nontaxable distribution made directly by the trustee of an IRA to organizations that are eligible to receive tax-deductible contributions. Of course, the main benefit of giving to a charitable organization is making a difference. Yet some tax benefits reward the philanthropic. Making a QCD can help you reduce your taxable income while supporting qualifying charitable organizations.
*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.
Tip adapted from IRS.gov
High Yield Savings Opportunity
GTS Financial has partnered with Flourish Cash to offer high-yield online savings accounts to our clients. Flourish is currently yielding 4.25% APY, there is no cost to get signed up, no fees, just more money in your pocket.
Please reach out if you are interested!
Financial Wisdom - A Snapshot of the US Dollar Index
Predicting the direction of the dollar, or any currency, can be a daunting task, even for professionals who specialize in it. One thing we can provide is some context.
As indicated in the chart, as of 2/28/23, the U.S. Dollar Index (DXY) remained elevated when compared to the 10-, 20-, and 30-year averages. If the dollar were to start falling, this could boost international investments – something we’re keeping an eye on. From a currency exchange standpoint, now may also be an ideal time to travel abroad as your dollar will stretch further.
GTS in the News - Grant Speaks at Financial Planning Association of Minnesota Panel
Grant was selected to speak at an industry event to share more about the unique ways we serve our clients and how our business has flourished as a result. We continue to seek ways to make our client experience unrivaled. If there’s anything we can do to better serve you, we’d love to hear from you. Always feel free to drop us a line at hello@gtsfinancial.com
Healthy Living - What are Polyphenols?
If you’ve researched whole foods much, you’ve likely come across the term “polyphenols.” But what are polyphenols, and why are they important?
Polyphenols are a category of plant compounds that act as antioxidants, which can neutralize harmful free radicals. Because of this, polyphenols may offer various health benefits, from boosting brain health and digestion to protecting against heart disease, type 2 diabetes, and even some cancers.
There are many sources of polyphenols, such as dark chocolate, tea, apples, oats, and turmeric. There are several categories of polyphenols, including flavonoids, phenolic acids, and polyphenolic amides.4
To learn more about polyphenols and their role in aging, click the link below to listen to one of our favorite longevity experts, Dr. David Sinclair, interviewed on the Lewis Howes podcast.
Learn more and listen to the podcast here.
Tip adapted from WebMD
Mindset - Feeling Stressed? Zoom Out.
When you are stressed, it is easy for your mind to spiral towards negativity and get stuck in a pattern of rumination and catastrophizing.
Stress can narrow our vision, like a spotlight. Rather than seeing the big picture, we focus our attention, thoughts, and actions on the perceived threat, neglecting whatever is blacked out in the periphery. In some circumstances, like an athlete zeroing in on the task at hand to score the game-winning point in a clutch moment, this spotlight can be beneficial.
For the type of stress that most of us face, however, keeping our focus too narrow for too long will be more likely to hinder our performance. Instead, we may benefit from turning on the floodlight.
When we zoom out, we take in more information so we can find a solution. According to research, adopting a broad state of mind shifts our actions to become more exploratory, and our perception, attention, thinking, openness to experience, and even mood will shift with us.
When stress or anxiety overwhelms you, consider trying one of these 5 tools for zooming out, and you may find that are able to deal with the situation more productively and (perhaps) creatively.
Visual Zooming
If you’re nervous, try taking your glasses off to force your visual system to go broad. If you don't wear glasses, soften your gaze and focus on the periphery to enhance creativity.
Linguistic Zooming
When we switch our self-talk from first person to second or third person, we are creating psychological distance, which dampens down our emotions.
During World War Two, co-pilots discovered that talking in a calm voice with clear commands snapped scared pilots in dire situations out of inaction. Decades later, researchers discovered that reminding pilots to broaden their attention throughout a stressful landing improved performance markedly.
Cognitive Zooming
Adam Smith wrote that we should be able to adopt the view of an "impartial spectator" to decrease the stress created by our own perceptions. Ask yourself, “What advice would a friend give me in this moment?” to zoom yourself out of a spiral.
Temporal Zooming
When we narrow our focus, we discount the future. To break this cycle, we need to zoom out and think about how our future selves will judge our actions now. Anyone can tell themselves at mile 19 of a marathon that it makes sense to quit – it’s painful in the moment. But, how will you view this struggle when you are at the finish line? The same can be applied when you’re panicked in the middle of a big project at work. How will this project look one year from now?
Physical Zooming
Changing our posture can shift our state of mind. In one study, participants were randomly assigned to sit either on the edge of their seats or to sit fully reclined before taking on a task of categorizing a group of pictures presented to them. Those who were reclined in their chairs were more likely to assign broad, creative categories (such as placing a vehicle and a camel in the same grouping), whereas those on the edge of their seat tended to stick to much narrower categories. When all else fails, a simple change in our physical position can change our thinking and perception.
Article based on The Growth Equation blog.