by Chris Ryon, CFA, & Sweta Singh – Portfolio Managers
A recent headline proclaimed that no one under the age of 40 has ever seen an aggressive Fed. It’s an interesting observation and is hopeful for those of us over 40. But this environment calls for experienced managers who have seen one or two full interest rate cycles. Now more than ever, a methodical approach to fixed income markets is needed. It is clear that the Federal Reserve is poised to tighten.
The need to act is clear. The headline Consumer Price Index (CPI) accelerated to a year-over-year gain of 7.5% in January—a 40-year high—while the Core CPI (excluding energy and food) and the core personal consumption expenditures price index remained well above the Fed’s 2.0% target rate. Meanwhile, producer prices jumped 9.7% in 2021, the largest calendar-year increase in the index’s history. Are these readings sustainable? We think not. Is the Fed target of 2.0% achievable? We think not — at least not in the medium term.
Bloomberg.com recently reported that Christine Lagarde, President of the European Central Bank (ECB), “delivered surprisingly hawkish comments” at the ECB’s February 3 policy meeting:
“Concern was across the board,” [Ms. Lagarde] said, explaining officials’ reaction to another record reading for euro-zone inflation released the previous day. “Our March meeting, and then later on, our June meeting will be critically important to determine whether the three criterias of our forward guidance are fully satisfied.”
The Fed agrees. In a statement from its January 26 meeting, the central bank stated ,“it will soon be appropriate to raise the target range for the federal funds rate,” possibly as early as March. If policymakers follow through, it will be the first-rate hike since December 2018 and the end of an era of free money.
In addition to hinting at the possibility of three rate hikes in 2022, policymakers signaled that the central bank’s monthly bond-buying is expected to end in March. The Fed also talks about managing down its balance sheet of some of the securities it purchased during the pandemic. That could be through roll down (allowing these securities to mature) or an active sale program. Both these actions should steepen the slope of the yield curve.
We believe these policy shifts make logical sense. If the Fed raises short-term interest rates and does nothing else, the curve may flatten or invert, sending a signal to the market of an impending recession. The current economic picture does not seem to be at risk of a near-term recession. Actively reducing (versus rolling off) securities on the central bank’s balance sheet limits that false recession signal and gives the Fed dry powder for future interventions.
Indeed, the new year has started with a bang.
| 2/11/2022 | 12/31/2021 | Delta | |
| 1 Yr. Treasury | 0.75% | 0.39% | 0.36% |
| 5 Yr. Treasury | 1.61% | 1.26% | 0.35% |
| 10 Yr. Treasury | 1.78% | 1.52% | 0.26% |
| 30 Yr. Treasury | 2.07% | 1.90% | 0.17% |
Source: Bloomberg, City Different Investments Calculations
| 2/11/2022 | 12/31/2021 | Delta | |
| 1 Yr. AAA Municipal GO | 0.80% | 0.17% | 0.53% |
| 5 Yr. AAA Municipal GO | 1.37% | 0.57% | 0.80% |
| 10 Yr. AAA Municipal GO | 1.62% | 1.04% | 0.58% |
| 30 Yr. AAA Municipal GO | 2.02% | 1.48% | 0.54% |
Source: Bloomberg, City Different Investments Calculations
| 2/11/2022 | 12/31/2021 | Delta | |
| 1 Yr. US Corp IG | 1.16% | 0.70% | 0.46% |
| 5 Yr. US Corp IG | 2.53% | 1.94% | 0.59% |
| 10 Yr. US Corp IG | 3.15% | 2.56% | 0.59% |
| 30 Yr. US Corp IG | 3.56% | 3.06% | 0.50% |
Source: Bloomberg, City Different Investments Calculations
The pandemic has brought about many changes to the economy. The good news: The economy is resilient. The not-so-good news: There is no playbook for the aggressive actions the Fed took to combat the pandemic and the long-term impacts these actions will have. However, our playbook remains the same – in this or any environment:
For additional insights on inflation and other topics, visit our blog.
IMPORTANT DISCLOSURES
The information and statistics contained in this communication have been obtained from sources we believe to be reliable but cannot be guaranteed. Any projections, market outlooks or forecasts discussed herein are forward-looking statements and are based upon certain assumptions. Other events that were not taken into account may occur and may significantly affect the returns or performance of these investments. Any projections, outlooks or assumptions should not be construed to be indicative of the actual events which will occur. These projections, market outlooks or estimates are subject to change without notice. Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product, or any non-investment related content, made reference to directly or indirectly in this communication will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. No discussion or information contained herein serves as the provision of, or as a substitute for, personalized investment advice. To the extent that a reader has any questions regarding the applicability above to his/her individual situation of any specific issue discussed, he/she is encouraged to consult with the professional advisor of his/her choosing. City Different Investments is neither a law firm nor a certified public accounting firm and no portion of this content should be construed as legal, tax, or accounting advice.