Don't Fight the Fed - Revisited

By Financial Advisor Frank Koster | November 8, 2022

The title of our third quarter update letter was “Don’t Fight The Fed.” It’s a long-standing adage of our industry that implies the U.S. Federal Reserve is the 800-pound gorilla in the room, and market participants should not bet against their intentions. Their intentions, for the year to date and foreseeable future, center on raising interest rates in an effort to slow the economy and thereby lower the currently high level of inflation.

When I first started my career in 1979, the minutes for each meeting of the Federal Reserve were not made public until a year after they were recorded, making them effectively useless to anyone trying to factor those minutes into their investment decision making process. Today, the Fed telegraphs their intentions, sometimes months in advance of upcoming meetings. Such has been the case this year, with relatively clear guidance from Fed Chair Powell on both the pace and magnitude of interest rate hikes we should expect. Further, immediately after each meeting, the Chairman holds a press conference detailing every element of the discussion the group had over the prior two days.

Through the third quarter of 2021, the Fed had been sticking to their belief that heightened levels of inflation would be temporary, and that price levels would decline as supply chain issues and other inflation catalysts abated. As it became obvious this was not going to be the case, they toggled their view and telegraphed to the markets that they were going to be raising interest rates aggressively to start 2022. They added a modifier stating the pace and ultimate level of rates would be driven by actual economic data, which would inform the efficacy of their actions. This modifier left room for interpretation by market participants, and has led to intermittent stock market rallies several times so far in 2022. Each of these rallies has been short lived however, highlighting the futility of fighting the Fed!

Higher interest rates have implications for markets far beyond stocks and bonds. The historically low interest rates of the last several years had the effect of inflating asset prices, including stocks and bonds, housing, commercial real estate, and even cryptocurrencies. As interest rates have moved dramatically higher, we are in the process of re-pricing those asset classes. Where we are in the process is hard to tell, but listening to The Fed, it is reasonable to assume that the near-term path for short-term interest rates is likely still higher. Don’t fight that…