Dear Friends,

There are plenty of reasons why inflation is at a 40-year high starting with low-interest rates, rising wages, supply chain disruptions, and fiscal stimulus that has fueled demand for consumer goods. And all of this is happening at a time when food and energy costs are rising.

The Fed officials long had said they expected the inflation surge to be “transitory,” as it is being driven by supply chain and demand factors largely associated with the pandemic. However, Fed Chairman Jerome Powell recently said it’s time to retire the word as it tends to cause confusion among the public.

Instead, Fed Chief Powell seems determined to bring inflation back under control, and that means the Fed is contemplating a series of rate hikes in 2022. His more aggressive approach created volatility in January, as investors attempted to price in several rate hikes this year.

Now let’s look at recent history and briefly dive into the numbers so we may paint a picture. During the 2004 to 2006 rate-hike cycle, then-Fed Chairman Alan Greenspan said rate increases were likely to be “measured,” as he embarked on a series of quarter-point rate hikes.

His goal was to reassure investors and avoid rocking financial markets. Fed Chief Janet Yellen and later Powell also soothed anxieties by signaling rate hikes would be “gradual” when rates slowly began to increase in late 2015. “Gradual” wasn’t as opaque as “measured,” but the goal was the same: reassure investors. Greenspan and his successor Ben Bernanke raised the fed funds rate from 1% to 5.25% in a predictable series of quarter-percent increases. Yellen and Powell hiked the benchmark rate from 0%-0.25% to 2.25%-2.50% through an uneven series of quarter-point increases, or 25 basis points (bp). One bp = 0.01%.

At Powell’s late-January news conference, he wasn’t making any promises on how quickly rates might rise. He wouldn’t rule out a rate hike at every meeting, beginning in March (there are eight scheduled meetings each year, including January). He didn’t dismiss the possibility of a 50bp increase in March. And, there was no mention of ‘gradual’ or ‘measured.’

All these changes (and speculation), has been a lot for the market to digest. Hence causing the volatility during the last few weeks (among other things). This volatility is likely just beginning, as the market anticipates, witnesses, and digests several interest rate increases this year (and possibly next). The important thing to note, however, is that equity prices can increase during periods of rate hikes, particularly when the rate hikes start from a very low-interest rate, to begin with. Having said that, although we believe volatility is the “new normal,” remember that the market has an upwards bias and a modest repricing is actually a healthy thing for the equity markets.

Please reach out if you have any questions.

Debbie

“The Russell 2000 is a stock market index measuring the performance of 2000 small-capitalization stocks. It represents the 2000 smallest companies in the Russell 3000 Index, which in turn represents the 3000 largest companies in the U.S. Thus, the Russell 2000 is a barometer of small-cap stocks. Though small, the companies represented by the Russell 2000 are not the smallest of the small as they are not penny stocks. The Russell 2000 is weighted by the market capitalization of the stocks.”

“The MSCI ACWI Ex-U.S. is a stock market index comprising of non-U.S. stocks from 22 developed markets and 26 emerging markets. It is made up of 2,361 constituents, which is 85% of the global equity market aside from the U.S. Sectors covered in the MSCI ACWI Ex-U.S index include health care, industry, finance, consumer staples, and information technology.”

“The EAFE is a broad market index of stocks located within countries in Europe, Australasia, and the Middle East. The EAFE Index contains more than 900 stocks from 21 countries. Investors and asset managers often use the EAFE Index as a performance benchmark for global developed market equities.”

“The Bloomberg US Aggregate Bond index includes government Treasury securities, corporate bonds, mortgage-backed securities (MBS), asset-backed securities (ABS), and munis to simulate the universe of bonds in the market. It tracks bonds that are of investment-grade quality or better.”