Commonwealth

Brad here. Yesterday, I laid out why I am not concerned, in general, about what a yield curve inversion means for the economy, while still being very aware of the increasing risks. Today, Anu Gaggar is taking a more detailed look at what inversions have historically meant for the markets. Although she too sees rising risks, she is also less concerned in the short term—so let’s hope we are right!

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One of the outcomes from the recent Fed meeting, where the Fed decided to raise rates for the first time in years, was a clear plan to continue to raise rates over the next year. Fed Chair Jerome Powell added fuel to the fire yesterday when he said that the Fed was willing to raise rates even faster than the meeting notes suggested. The Fed is now clearly focused on bringing inflation back down, even if it means slowing down the economy.

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Last week was jam-packed with economic updates and reports that covered a variety of sectors. The February retail sales report was one of the more widely monitored updates, as it showed that consumer spending continued to grow during the month. But the pace of sales growth slowed compared to the start of the year. This will be a relatively quiet week, with only one major update scheduled.

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This week, we have been talking about interest rates and the Fed—and what that all likely means for our investments going forward. But behind those conversations is another more fundamental question: what should interest rates be? If there is some natural rate where interest rates should be, that could give us some guidance as to where they will end up. That is really what we should be looking for as we plan our portfolios over the long term.

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One of the things we know, mathematically, is that if interest rates go up, stocks should go down. If you consider a stock price as the discounted present value of a future earnings stream, then a higher discount rate results in a lower present value. There is no nuance or context; it is just math. So when rates are raised—and prospects for future raises are reinforced—and yet stocks move up, there is clearly something else going on.

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With the regular meeting of the Fed this week, there was a great deal of speculation about what it would do. As expected, the Fed pulled the trigger on a 25 bp interest rate hike. But what will happen next? What I expect from the statement, as well as the press conference, is that there will be similar hikes at every meeting for the rest of the year (data permitting) and that quantitative easing bond purchases will be wound down by the end of the year. In other words, I expect the Fed to follow up the rate hike with signals that it will continue normalizing policy, and I don’t expect that to be derailed by the Ukraine war.

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