Market volatility is continuing. The Federal Reserve has a limited number of tools in its toolbox to help curb inflation. Inflation is a product of supply and demand. Demand has been strong as consumers had plenty of cash in their pockets coming out of the pandemic. They wanted to put that cash to work in products and services.
However, at the same time that consumers wanted to spend money on products and services, there was a lack of workers, high energy costs, and supply chain issues that affected the costs of goods and services.
The high demand for an increased cost of goods sold as well as costs of services has increased inflation dramatically. The May consumer price index was a game-changer. Many had hoped that that number would be lower and in fact, came in much stronger than anticipated. That took the market down another leg.
The Federal Reserve only has two main tools to reduce inflation. They can raise short-term interest rates which increase the cost of borrowing for consumers and businesses. They also can sell the bonds that they have in their inventory. As the Federal Reserve sells bonds that will increase the yield on the longer end of the yield curve for bonds. This also affects consumers’ and businesses’ borrowing costs. This is a disincentive for borrowing and reduces the output of our economy.
The Federal Reserve’s mission is twofold stable prices and full employment. We don’t have stable prices and have an inflationary environment. The Federal Reserve has to control inflation and the tools they have are like a blunt instrument. They will want to beat the economy over the head until it stopped buying stuff. Essentially, they want asset values to go down so people feel less wealthy and spend less. They will sacrifice higher unemployment to get control over prices.
So, what’s this means for the stock and bond market. For right now, the Federal Reserve is not an investor’s friend, and this creates a headwind for the market. This will continue until the Federal Reserve starts to cool inflationary pressure. Also, higher energy costs will affect production to motivate producers to produce. As the unemployed start to run low on cash many that are outside of the job market will reenter the workforce and this will also help with supply chain issues.
Hopefully, the federal government will assist businesses to smooth out the supply chain and increase products and services. Also, we need the federal government to help with all different types of energy supplies that are necessary to keep costs down. This is all part of the normal business cycle and will resolve itself in the relatively near future. Meanwhile, we will adjust portfolios take losses where appropriate, and position ourselves for the next leg higher.
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.