Insights & Advice

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Fed feels inflation heat

This week’s Federal Open Market Committee meeting was a game changer. Fears that inflation may be rising faster than expected forced the Fed to adjust their timing on when to begin withdrawing monetary stimulus. The markets didn’t like that.

It was a downside surprise that sent the U.S. dollar soaring, commodities plunging, and some equities sinking. What investors feared most at first was another “Temper Tantrum.” In 2013, and again in 2018, the Fed’s decision to withdraw monetary easing sent interest rates soaring and stocks plunging. However, it looks like this time around, the markets are taking the change in stride.

What may have saved the market this time was the Fed’s ability to convince investors that, whatever change may be in the works, it is not happening now. “You can think of this meeting that we had, as the talking about talking about meeting if you like. And I now suggest that we retire that term,”explained Fed Chairman Jerome Powell, in the Q&A session after the FOMC announcement.

The main changes to monetary policy that were announced at the FOMC were in three areas. The Fed projected two interest rate hikes in 2023, which is sooner than they previously forecast. At the same time, they upgraded inflation estimates for each of the next three years. Finally, the opening of the tapering conversation that Chairman Powell referred to.

The biggest financial losses were within the commodity complex. Precious metals followed by copper, and food products, etc. led the declines. Some commodities suffered more than 5% losses for the week. Lumber had already reversed its gain and has been in free-fall for the past two weeks.

While the bloodbath was severe, investors should realize that these commodities have had fantastic gains during the last six months. Commodities are known for their extreme volatility, which is why I say that they are only suitable for investors with a high degree of risk tolerance.

Does this mean that the commodity trade is over?

No one really knows. The bulls argue that there is no way commodity prices can do anything but move higher (after this bout of profit-taking), given the strong economic growth and the recovery of global demand.

The bears point to the Fed’s actions believing that price increases will at least slow, if not reverse, the sharp price increases of the past. They point to other nations that are also taking action to quell the commodity price rise. China, for example, released its substantial stockpiles of copper, zinc, and other metals last week to local buyers in order to dampen the price hikes that were feeding inflation in their country and around the world. So far, these government actions are working.

This week’s Fed about-face reveals some unsettling facts. The central bank (as well as investors) is grabbling with a series of future unknowns. The present economic data is at best unreliable. The unpredictable nature of the reopening, coupled with trillions of dollars in fiscal and monetary spending, makes forecasting difficult.

The gains in the labor market have also been all over the map. Many millions of workers are still out of work, even though there are millions of unfilled jobs around with no takers. Bottlenecks in the supply chain, which are supposed to be “transitory,” are adding to price hikes that may, or may not, reflect real demand for goods and services.

It is going to take investors a bit of time before they can decide how to approach the next six months of investments. Over the last two days, we have seen a lot of the materials, industrials, financials, and small cap stocks fall, while large cap technology shares have been bid up. The bond market, despite the Fed meeting, has seen little movement with the U.S. Ten-Year Treasury bond hovering around 1.50%.

Given this background, I expect to see heightened volatility in the short term, but we probably won’t see any big moves in the equity markets–unless investors decide over the weekend to stage a temper tantrum over tapering.

Investments in securities are not insured, protected or guaranteed and may result in loss of income and/or principal.  This communication may include opinions and forward-looking statements, and we can give no assurance that such beliefs and expectations will prove to be correct. Investments in securities are not insured, protected or guaranteed and may result in loss of income and/or principal.  This communication may include opinions and forward-looking statements, and we can give no assurance that such beliefs and expectations will prove to be correct.

 

 

 

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