Inflation? Tapering? Tightening? Oh My!
I can hardly get through any news report or recent article which does not mention “inflation” in some context. If you are over the age of 60, or have studied the inflation of the 1970’s, you may immediately call up an image of mortgages and money market funds at 17% or more. What we have this time around is not that!
This current bout of inflation stems from the disruptions caused by the pandemic.
Let’s take lumber for example, the subject of some hilarious memes. Plywood and lumber prices in general went “through the roof” in early 2021 months. Sawmills had shut down in 2020, delivery truckers were laid off, and the production of lumber products almost disappeared. As we emerged from the pandemic closures, housing demand grew, and lumber supplies were nowhere to be found. So…Price up!
With the reopening of the economy, and as vaccinations allowed more workers to return to the many stages of lumber production and distribution, the supply of lumber is becoming more in line with its demand. Lumber prices are falling, and, according to the New York Times today (6-21-21), they are down 45% from their peak. A balance between supply and demand is re-establishing itself.
In recent remarks following the Federal Reserve meeting of last week, Jerome Powell’s statement that the committee, being “data dependent”, is observing that some data are pointing to the possibility that Tapering may begin sooner than the committee had indicated previously. In fact, we saw indications of hawkish members suggesting that Tightening might come as early as late 2022. The stock market did not like those remarks, and we saw a drop in the Dow over several days last week. The message from the Federal Reserve and the Treasury Secretary remains fairly consistent, however. This spurt of inflation is “transitory;” it’s not going to last and not likely to build from here.
The Bond market agrees.
Long term interest rates, the 10 year and 30 year Treasury Bond rates, have actually fallen in recent days, not risen. We see this adjustment as an indication that low inflation is the more likely scenario.
We should point out that Tapering will occur before Tightening, and Tapering is NOT Tightening. Tapering will be the reduction in the monthly buys the Federal Reserve makes of bonds such as Mortgage Backed Securities and Treasury Bonds. This strategy has worked to keep long-term interest rates – and your variable mortgage rate – historically low. Tightening will likely not occur before 2023. Tightening will be the first step in normalizing interest rates, in the gradual raising of interest rates – the Fed Funds rate – the rate most banks use to set interest rates for deposits and lending.
Why do we care about interest rate movements?
We care because the stock and bond markets care deeply. Both markets can adjust to gradual movements up or down in interest rates; it is the sudden and spikey movement of interest rates, particularly up, to which both stock and bond markets react negatively.
We believe, along with the Federal Reserve and many economists, that supply and demand will come back into some acceptable balance, supply chain disruptions will diminish, and this will occur within a robust Post-pandemic GDP growth. This scenario should offer the stock market room to grow, albeit not without some volatility, and the bond markets to remain relatively stable.
As always, we too are ‘data dependent’ and our quarterly rebalancing will seek to capture opportunity while positioning away from identifiable risks.
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