ATurningof theTide
Checktheinflationandinterestratetide timetablesbeforeyouendupontherocks.
ByPatrickBowen,MASECOPrivateWealth, WealthManager
ince2008,fromacertainperspective, wehavebeeninaconsistentmacroeconomicbackdrop,withthetidesheadingin onedirection.Thisbackdropbeing,verylow interestrates,or‘cheapmoney’.
Toexplainthisstatementfurther,from January2008untilDecember2022,theUS FedFundsEffectiveRate1wasalwaysbelow 4%.Morestrikingly,breakingthisdownto monthlyperiods,interestrateswerebelow 2%for86.67%ofthesemonthlyperiods andbelow1%for72.78%ofthesemonthly periods.Longstoryshort,thiswasasustainedperiodofverylowinterestrateswhich translatedtocheapborrowingconditions andwhatisotherwiseknownbyKeynesianeconomistsas,expansionarymonetary policy.
In2022,wesawastarkreversalofthese conditionsastheUSandglobaldeveloped marketslookedtoincreaseinterestratesin anefforttocombatrisinginflation,otherwise knownascontractionarymonetarypolicy. Giventhesustainedperiodofverylow interestrates,thecounteractionappearsto havebeenassevereintheotherdirection, atleastcomparedtohistoricinterestrate hikes.WhileIamsureweallawareofthe rateincreases,Ithinkitisimportanttoput intocontexttherateoftheserateincreases. Thechartshowshowthiscyclecomparesto previoushistoricalratehikes.
ThepaceofFedratehikesinthiscycle hasbeenrapid:
ofthetide.Thequestionis,whatimpactdoes thishaveforusasinvestors?
Asyoucansee,thecurveonthechart showshowtheserecentinterestratehikes havebeensteeper,thereforedeemedmore aggressive,thananyinthepastfortyyears. Itisimportanttobearinmindthisgraphis alreadyoutofdateandmostlikelywillbe asyouarereadingthis,withdatarunning totheendofOctober2022.InNovember andDecember,therewerefurtherratehikes bringingtheFedFundsRateto4.5%asof theendof2022.
WithsuchadrasticchangeinUSinterest rates,itishardnottoconsiderthisaturning
Impactoninvestors
Oneareathisishavingaverysignificant impactisinthebondmarket.Forthosewho arenotseasonedinvestors,thetypicaland mostcommoninvestmentsonemakesare instocksandbonds.Stockholdersareequity ownersinacompany.Bondholdersarelenderstoacompany.Withinvestmentsinboth stocksandbonds,youexpectanadequate returnforthetimehorizonandriskofthe investment.
Giventhemacroeconomicbackdropof historicallylowinterestratesthatwehave
beenlivingwithsincetheGlobalFinancial Crisisof2008,fixedincomeinvestmentsfell frompopularityasbondyieldswereless commensuratewiththeriskandreward equation.Assuch,amantraandacronym calledTINA–ThereIsNoAlternative(to stocks)–becamepopularwithinthefinancial worldformanyinvestors.Someinvestors haveturnedsolelytostockstohelpearn returnsthattheydeemcommensuratewith theriskandreturnequation.
However,withtheturningtide,itisbeing moreimportantforTINAsouttheretopay attentiontofixedincomegoingforward. Inanefforttoillustratethispoint,belowis oneexampleofhowtheserateincreases areimpactingthebondmarket,notablyUS governmentbonds.
Inthelowinterestrateworldofjust18 monthsago,One-YearUSGovernment Treasurieshadayieldofroughlyjust0.07%. Afteranyapplicabletaxesandinvestment charges,thiswasnotanattractivereturnand addedfueltotheTINAsfire.Fastforward tothetimeofwritingattheendofJanuary2023,andasIlookatthingslivefrom mycomputer,forthesameinvestmentof OneYearUSTreasuries,yieldsarearound
4.763%3.Forthoselessfamiliarwiththe landscape,thatisasignificantchangeinUS governmentbondyieldsandisillustrativeof theturningtide.
ForalltheTINAsoftheworld,itlookslike thisturningofthetideisprovidingthealternativetheymayhavealreadydismissed.
Afamousanecdotebylegendaryinvestor HowardMarksabouttheeconomyandmarketsremindsus“weneverknowwherewe’re going,butweoughttoknowwhereweare”4 .
Itisimpossibletoknowexactlywhen inflationwilldampenorinterestratehikes willstarttoslowdown,levelofforeven reverse.Whatwedoknowisthatinflation andinterestratesarehighertodaythanthey havebeenfor40and15years,respectively, anditisimportantthatinvestorsstoptotake noteofthis.
Thebottomlineformeisthat,inmany ways,conditionsatthismomentareoverwhelminglydifferentfromthosewebecame usedtoaftertheGlobalFinancialCrisisAs mentioned,itfeelsliketherehasbeena turningofthetide.Whenthetideisturning, youneedtobefullyawareandcarefuloryou couldendupontherocks.
ForallthediehardTINAsoftheworld,or
thosewithtoonarrowaninvestmentideology,Iwouldrecommendcheckingthetide timetablesandfollowingthewordsofwisdomfromHowardMarksinknowingwhere weare,andadjustingcourseifnecessary, beforeendingupontherocks.H
*Chart:FederalFundsTargetRate(FDTRIndex),Oct22 31,2022Source:BloombergThisistheshort-term interestratetargetedbytheFederalReserve’sFederal OpenMarketCommittee(FOMC)aspartofitsmonetary policy
1https://fredstlouisfedorg/series/FEDFUNDS
2https://wwwschwabcom/learn/story/fixed-incomeoutlook
3https://wwwmarketwatchcom/investing/bond/ tmubmusd01y?countrycode=bx
4https://wwwoaktreecapitalcom/insights/memo/seachange
PatrickBowenisaWealthManageratMASECO PrivateWealth.
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