Today’s market selloff is all about the Federal Reserve. As I mentioned before, the Federal Reserve is the great slayer in bull markets. One of the reasons the market has done so well coming out of the pandemic is the Federal Reserve backstopped the economy with its bond purchasing program and ultralow Fed funds rate. During the height of the pandemic, this bond purchasing program may have saved our economy and helped us as a country recover. However, times have changed.
We all knew that the Federal Reserve was going to start tapering its bond purchasing. I think that’s a good idea. Their bond purchasing has driven down interest rates to a level that makes it very hard for those who use fixed income to live on. The high inflation rates have degraded these investors’ standard of living.
Many economists and market pundits tie the tapering of bond purchases to the Federal Reserve, ultimately raising short-term rates. I don’t believe the two are necessarily tied. Clearly, they are going to taper bond purchases first and possibly will be finished with bond purchasing in February. If the economy is strong enough, this will allow interest rates to rise. That will put some pressure on the market, but not nearly as much as them raising the federal funds rate. I’m still in the camp that increases in the Fed funds rate will be delayed towards the end of next year.
Today was the first day of Federal Reserve chief Jerome Powell’s testimony before Congress. He was definitely more hawkish than he had been in the past. He took away the term transitory from the discussion around inflation. It is possible that he may walk back or clarify what he means by inflation not being transitory in his testimony tomorrow.
Obviously, all this is in the backdrop of the new COVID strain which was originally the concern with the market on Friday. We now have a concern of the Federal Reserve that may be tighter than what was projected. I don’t believe you can have both. If the COVID strain has an impact on the economy, the Federal Reserve will not be raising short-term rates.
Normally, a rate raising cycle doesn’t impact the market in a meaningful way unless you get three or more hikes in succession. By accelerating the tapering of bond purchases they may be able to delay raising short term rates.
We also had a weaker consumer confidence number than expected. The Case Shiller home index was lower-than-expected. The housing market is still hot but slower than what was expected.
So what does all this mean for the markets? I still believe we are going to have an end-of-the-year rally and a solid market into the first part of next year. Certainly, we can have corrections along the way such as were having today. However, if the virus is an issue for the economy, the Federal Reserve will not raise rates. They may taper their bond purchases and hold off on raising rates.
The market hates bad news or uncertainty. It got a little of both today. However, the economy is still expanding and companies’ earnings are good. Earnings will drive the market higher. The stock market is still cheaper than the bond market. Even though the Federal Reserve is talking hawkish, it is still extremely accommodative.
The views stated in this letter are not necessarily the opinion of Cetera Advisor Networks LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.