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29 Aug 2024

Interest Rates Are Coming Down: The Good & The Bad (not too ugly)

By glen

Interest rates have been elevated for over two years now.  This is the result of the Federal Reserve fighting the post pandemic inflationary fire.  Higher rates are the primary way to lower inflation, and this is a time tested remedy, rewarding savers, while punishing borrowers and some investors.

Let’s look at where we are now, where we’re headed, and the anticipated impact of the coming changes.

Where We Are

Higher rates have rewarded cash savers for the first time in a generation. With money market rates exceeding 5%, it’s been a nice return for zero risk.  CD yields have been juicy too.  It’s a boon for those who can’t stomach investment risk, and very nice for those of us who hold some cash in a diversified portfolio.  For others it has been a painful struggle.

Bonds are important to all but the most aggressive investors and bond prices tanked as rates were pushed up.  A bond’s price moves inversely to yield (interest rate).  Yields going up means prices going down, and that’s painful when bonds are supposed to offer safety.

Home prices spiked as the pandemic peaked, and the value of everything went up all at once due to the flood of cash that led to the inflation spike.  This was followed by a painful increase in mortgage rates.  These are the highest mortgage rates in a generation, keeping many people out of the home market.  People with super low mortgages had no incentive to move, and trade up or downsize, which translated to a lack of sellers and homes families and aspiring families could afford.

Lending markets of all types have struggled making it harder for the economy to grow, while higher rates have tamed an economy that was on fire with inflation.  The list goes on regarding the pain of higher rates.  Auto loans have been a burden for many families, and small businesses have struggled with financing because they tend to borrow for shorter terms at rates that are higher even when rates are “normal”.

Where We’re Going

Inflation by all measures is trending back toward pre-pandemic norms, which is around 2.5%.  The job market is finally showing some signs of slowing.  This combination frees the Fed to begin cutting rates, and they’ve made it pretty clear this will begin at their September 18th meeting.

The market anticipates three to four rate cuts, totaling 0.75% to 1%, by the end of 2024, with a potential 2% drop over the next year. However, economic conditions can change rapidly.

The prices of longer term bonds have already begun to rise in anticipation, with people who sell bonds for a living waxing philosophically about the once in a generation opportunity in bonds.  In my humble view, this is just getting back the once in a generation loss we experienced as rates spiked.  Either way, bond prices rebounding is great news, getting us back to a new normal.

Mortgage rates will drop significantly as well.  They are already down more than 1% from highs in many markets.  That trend will continue, and hopefully, the residential real estate market will rapidly thaw as we head into spring.

Car loans will drop, allowing families to make better transportation decisions, and keeping auto workers employed and spending those paychecks further bolstering the economy.

Risk averse savers will have to say goodbye to juicy money market and CD rates.

Wrapping It Up

In many ways, this marks the end of pandemic era financial turbulence.  The ride down in rates will be refreshing for all but the ultra-conservative saver.

The trick for the Federal Reserve will be getting rates down fast enough to prevent a recession, which markets call a soft landing.  While bond prices may move quickly in economics there is a strong belief that it takes six months or more for any rate change to fully play out in the economy.  A September rate cut of ¼% will not be felt in American homes and businesses until March.  If a recession should happen next year, the consensus is that it will be short and shallow, with the headlines being worse than the reality for most.

If you have been enjoying the high money market and CD rates, we’re here to help you build a portfolio that meets a conservative risk tolerance for the long run.

 

 

 

 

Buoyant Financial, LLC is a registered investment adviser located in Charlotte, NC. Buoyant Financial may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements. A copy of Buoyant Financial’s current written disclosure statement discussing Buoyant Financial’s business operations, services, and fees is available at the SEC’s investment adviser public information website – www.adviserinfo.sec.gov or from Buoyant Financial upon written request. This note is for informational purposes only, and should not be construed as investment advice, or a recommendation to buy or sell securities. 

16 Feb 2022

Removing Life Support: Post Pandemic Challenges

By glen

 

When the pandemic began, the world’s largest economy was put into what can be thought of as a medically induced coma. The Federal Reserve and Congress took steps to ensure the patient would survive a trip to intensive care like no other. The world’s largest economy had never been put to sleep intentionally, and then revived.

Congress passed legislation to support employers, and employees, with things like paycheck protection, PPP loans, direct payments, and supplements to state unemployment benefits.

The Federal Reserve or “Fed” did what it knows how to do. It lowered interest rates, and printed a ton of money. The Fed essentially printed over four trillion dollars, that’s $4,000,000,000,000, for those who like to look at numbers. This flooded the US and global economies with cash.

These actions worked better than many expected. During 2021, the economy rebounded, and is now on a trajectory to pre-pandemic levels. Strong medicines can have strong side effects, and the most fearsome side effect of printing money is inflation.

The Fed had expected the inflation surge to pass quickly; however, supply chain issues caused inflation to become intrenched.

Wage increases became common, and are usually seen as a good thing. Who doesn’t like to make more money? However, as prices rise, wage increases are struggling to keep up. This begins what’s often called a “wage price spiral,” and it’s not a healthy pattern.

Most economists agree that it’s time to wake up the patient, and move out of intensive care. This analogy is important because if you’ve ever known someone who was in intensive care, the journey back to health is long and challenging. The economy became hooked on cheap money, and because of the inflation flare up, the Fed will have to move much faster than expected.

Next month, the Fed will stop buying bonds, which was a way of printing money, and is expected to begin increasing the fed funds rate. The fed funds rate is the overnight rate banks charge each other. It’s like the mother of all rates because it informs and influences everything from corporate bonds to car loans.

The market lives for expectations about what’s going to happen next. Last fall, the expectation was that the fed funds rate would increase 2 or 3 times this year. Each move is generally 0.25%. Inflation has become so wild that the expectation is now five to seven hikes this year.

For reasons I won’t bore you with, higher interest rates are generally the only way to tame inflation. For those of you old enough to remember, this was painfully, and successfully, demonstrated by Fed chair Paul Volcker in the 1980’s.

Now markets face a variety of challenges, which feed on one another. Just to give you a sense, here are a few of them:

• When interest rates go up, the price of bonds fall, hurting the “safer” side of portfolios
• When interest rates go up, stock prices tend to drop because it costs companies more to borrow, and new bonds at higher yields become tempting to investors when compared to stocks
• When interest rates go up, mortgage rates go up, making housing seem more expensive

The list goes on, but those examples really get to the point. It quickly becomes a sticky wicket for the Fed.

Rates will have to go up, and as you may have seen, this is already playing out in bond yields and mortgage rates. The Fed hasn’t actually done anything yet, but it’s ability to influence the markets is so strong that they move in anticipation. This also means the market agrees with the notion that the Fed has no choice other than to increase rates quickly, and begin vacuuming up the money it printed over the last two years.

The risk now: the Fed increases rates quickly to tame inflation, and ends up triggering a recession, or economic contraction. This has happened in the past, so it’s not a theoretical risk, it is very real.

Markets are constantly trying to look around corners, and into the future. While there is no expectation for a recession in 2022, there is now a real risk of one beginning next year.

What does all of this mean for our portfolios? While none of this is what investors want to hear, it’s not all bad news, and it’s a challenge all long term investors face from time to time.

Bond prices have dropped, but if you are: dollar cost averaging, reinvesting dividends, or both, you will be purchasing shares of bond funds at lower prices, and the new bonds in these funds will be issued at higher yields, which is good news for you long term. The other good news is that when a recession does come, and the Fed cuts rates, bond prices will rise, causing bonds to act as good ballast in what will be a storm.

Stocks have been overpriced for some time. While we don’t like to see stocks fall, we do like to see healthy valuations that make sense. Getting back to that point is better in the long run. And again, with dollar cost averaging, and dividend reinvestment you’ll end up purchasing stocks at lower prices, something long term investors love to do.

Those of us who plan to hold stocks for the rest of our lives, and will continue to buy along the way, don’t mind these ebbs and flows of the market. They present opportunities to buy what we love on the cheap, which is really ownership of the world’s largest economy.

If you have been speculating in stocks, day trading, buying what’s popular, and getting into the “meme stock” trend, it’s probably time to reconsider those positions and activities. The best way to invest in stocks for the long run is to purchase diverse, high quality portfolios, such as the S&P 500, with a plan to hold them for a long time.

These storms will come and go during our investing lives, they shouldn’t surprise us. While the pandemic economy was unusual, we’re seeing an economy and market returning to long-term norms in terms of growth, and it’s time for the Fed’s strong medicine to be withdrawn.

Even if there is a recession in the coming year or so, we should be prepared to weather that storm, and continue to grow our portfolios over the long run.

 

 

 

Buoyant Financial, LLC is a registered investment adviser located in Charlotte, NC. Buoyant Financial may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements. A copy of Buoyant Financial’s current written disclosure statement discussing Buoyant Financial’s business operations, services, and fees is available at the SEC’s investment adviser public information website – www.adviserinfo.sec.gov or from Buoyant Financial upon written request. This note is for informational purposes only, and should not be construed as investment advice, or a recommendation to buy or sell securities.