Client Login

4th Quarter: 2023 Edition

Markets & Economics Commentary

 ©2024 Mark P Culver

 

Russell 1000 Index: 2023 YTD +26.5%
Bloomberg Aggregate Bond Index: 2023 YTD +5.5%

 

 

 4th Quarter: 2023 edition

Lower Interest Rates in the Offing?

 

Front and center on most everyone’s mind in respect to the US Economy is the recent spike in inflation and the remarkable speed with which markets seem to have responded to higher Fed Funds rates in curbing that inflation.  I think it’s safe to assume at this point that the primary cause of the recent (2021-2023) inflation was the massive infusion of monetary and fiscal stimulus from both the Fed and Congress in response to the Covid-19 pandemic.  While it would have been more desirable to have targeted the stimulus better and more efficiently, it is understandable given the nature of the pandemic and the immediacy of affecting a response that US government used a simple shotgun strategy.  The analogy of dropping cash from helicopters comes to mind.  Given the magnitude of stimulus, the resulting inflation should not come as much of a surprise.

 

What is surprising is how quickly markets and prices, that is, inflation, have responded to 1) the termination of the stimulus, and 2) higher interest rates, particularly the Fed Funds rate.  For reference, inflation was anchored at a stable 1.5% to 1.8% for several years prior to the pandemic.  But only 9 months into the pandemic, and only 6 months after the “helicopter” money was released, inflation had spiked to nearly 9.0% by the beginning of 2022.  A dramatic increase to be sure.  One of the most frightening aspects of inflation is that higher prices can quickly become the expectation among consumers and producers.  In that kind of environment, higher inflation becomes almost inevitable.  Sort of a self-fulfilling prophecy.  It then becomes really difficult to quell inflationary pressures because the central bank and legislatures must first kill that expectation for higher prices, typically by raising interest rates much higher than would have been necessary otherwise.  That inflation has fallen over the last 2 years back to ≈3.0% suggests to me that the Fed and Congress did act quickly enough to prevent higher inflation from becoming “normal” and just part of consumer expectations.  Although 3.0% inflation is still materially more than the Feds 2.0% target, indicating that there is still work to do, the picture appears much brighter today than it did 2 years ago.

 

In fact, I would argue even further that all the speculation over how soon the Fed might actually begin cutting the Fed Funds rate, the general public’s overarching expectation is for lower interest rates and that any expectation of inflation was either quashed or never really took hold in the first place.  With that, I will turn to my skepticism around the prospect for the Fed to start cutting the Fed Funds rate dramatically.

 

Keep in mind, unlike most central banks in the world, the Federal Reserve has a dual mandate from Congress (most central banks have a single mandate, that being to defend the currency).  The Federal Reserve is charged also with defense of the currency, meaning preserving the purchasing power of the dollar.  It is also charged with ensuring maximum employment.  Generally, those two forces are somewhat in conflict with one another as high employment tends to fuel higher inflation.  Certainly, there have been instances where that relationship has not held up, for instance the 1990’s and most of the past decade, owing to massive technological advancements to make labor more productive.  But it is a relationship that the Fed concerns itself with.  If the Fed must prioritize one mandate over the other, it will always choose protection of the currency over maximum employment.  Inasmuch as unemployment in the US has been incredibly low for years, currently 3.7% as of December, there is zero justification for the Fed to lower the Fed Funds rate to stimulate employment.

 

The only story I can come up with to justify anything in the way of lower interest rates might be that longer term interest rates (5 Year Treasury yields, 10 Year Treasury yields, 30 Year mortgages) are simply too low relative to the more Fed induced short term interest rate.  Here, I am referring to the inverted yield curve we’ve been operating under for more than a year now.  If the Fed decides that inflation has been tamed and that a more normal shaped yield curve is in order, it is conceivable that a moderate cut to the Fed Funds rate might be in order.  I am not of the opinion that the Fed Funds rate will be cut back to 0%, or anything that might be considered “stimulative.”  However, cutting the Fed Funds rate from its current level of ≈5.33% to a range around 3.5%-4.0% could be justified.  At 3.5%-4.0%, all else being equal, the current yield curve would look much more normal with yields actually rising with longer maturities.

 

In that kind of environment where the yield curve might finally normalize from a moderate cut to the Fed Funds rate, certainly banks and other lending institutions should fare well.  As their cost of funds declines from the rate cuts and the interest rate they are allowed to charge on their loans stays relatively stable, the margin on their loan portfolios should expand fairly dramatically.  Obviously, if that environment begins to take hold, we would be inclined to weight more heavily into those types of financial institutions.  In addition, more growth-oriented companies that can generate higher rates of return than their cost of funds will perform better if their cost of funds (interest rates) are declining.  We believe the tech sector and heavy industrial would be the beneficiaries.

 

Therefore, we seem to be left with a potential transition from a “hawkish” Fed to a more neutral Fed.  How that plays out will determine much for investment performance this year.  We are certainly watching very closely and are ready to overweight those sectors and companies that should benefit in a more interest rate neutral environment.  But also protecting capital if that state does not materialize.

 

Please feel free to contact us if you have any questions or if you need to schedule an appointment to discuss your account or financial plan with us.  This is particularly important if you have experienced a big change in your life recently (got married, retired, changed employment, bought/sold a business, etc.).

 

2023 Form ADV Notice and Offering – the firm’s 2023 Form ADV Part 1 & Part 2 filings with the Securities Exchange Commission was filed 03/10/2023.  If you would like a copy of this important disclosure document, please contact us at (303) 442-3670 or [email protected] and we will be happy to deliver it to you at no charge.

 

Privacy Notice – the firm’s privacy notice, which details how we handle and/or may share your private information within the firm and with certain partner firms in servicing your account, is included in the 2023 Form ADV Notice.  Please refer to that document to review our Privacy Policy.  If you would like a copy of this document, please contact us at (303) 442-3670 or [email protected] and we will be happy to deliver it to you at no charge.

 

Sincerely,

Mark P. Culver

Managing Partner
Recent posts
 
Categories
Follow us
Facebook Twitter Instagram
Featured post

Related Post

Colorado Based Financial Planning
Get Social
Facebook Linkedin
CONTACT US 
Epiqwest Culver Wealth Advisors, LLC
Find Us On map!
© 2024 Epiqwest Culver Wealth Advisors, LLC, All rights reserved. Privacy Policy.

Investment advisory services offered through Epiqwest Culver Wealth Advisors, LLC, an SEC Registered Investment Advisor. Insurance services offered through licensed professionals of Epiqwest Culver Wealth Advisors, LLC.