Weekly Market Update May 5, 2023
Dow Jones Industrial 33,674 +1.6%, S&P 500 4,136 -0.8%,
Nasdaq Composite 12,235 +0.1%, US Ten Year 3.43%, West Texas Intermediate $71.36
10 and Done Rate Hikes?
This week the Federal Reserve raised rates for the 10th consecutive time since March of 2022. Powell and company raised the Fed Funds rate to the 5.0 – 5.25% range, as expected by markets. More importantly, the Fed dropped from its policy statement the language saying that it “anticipates” further rate increases would be needed. Powell, during the press conference following the announcement, left the door open for possible future action, saying “we are prepared to do more.” General market sentiment indicates that most investors think the Fed is done hiking rates (for now), and this is certainly the story told by the Treasury yield curve. Three-month T-Bills are yielding 5.25%, while 6-Month Bills are yielding 5.02%, and one-year bills are yielding 4.67%. As we have discussed many times in the past, such a substantial yield curve inversion is an ominous signal for economic growth, more often than not predicting a recession.
As we have also pointed out in the past, a recession for the economy doesn’t necessarily translate to poor performance of the stock market. Markets are forward looking, and many pundits are arguing that a recession is already priced into stocks (and bonds). For those who do not buy into this camp and are still more comfortable sitting on the sidelines for the time being, cash management should be your number one priority. Prior to 2022, cash balances were an afterthought because deposit, money market and C/D rates were negligible. That has changed dramatically over the last 12 months with the Fed’s 10 interest rate hikes, and investors now have an alternative to generate real income with little to no counterparty risk (1). The chart below is of the U.S. Federal Funds rate, going back 10-years. The latest readout (not captured on the chart) would show an uptick to the line to the 5.0 – 5.25% level.
- Treasury bills are considered “riskless” from a counterparty perspective, because the counterparty in this case is the U.S. Government. For those investing in C/Ds, the FDIC insures balances of up to $250,000 in the case of any bank failure.
The following chart shows inflation, as measured by the CPI Index, over the last 10-year period.
From this information we can see how rate hikes have begun to slow inflation. And those investors who have been taking advantage of short-term Treasury Yields have been able to stave off inflation to a certain extent. For example, an investor who purchased a 12-month Treasury ladder yielding ~5% in February of 2023 was still losing ~1% to inflation (as inflation in February was ~6%). With the last rate hike, investors seeking to build income can not only stave off inflation, but even BEAT inflation based on current rates. The chart below shows the Fed Funds Rate minus the CPI Index. In short, when the number is positive, the Fed Funds rate (which is the basis for determining interest rates across the market) exceeds the CPI (inflation index) and that is what we refer to as positive REAL returns.
As you can see, with the last rate hike we’ve now entered a positive “fed funds minus CPI territory.” For those investors who aren’t ready to wade into equity markets, we continue to advocate a short-term Treasury and/or C/D income ladder. Not only will it yield substantial returns, it will now allow you to beat inflation and generate positive real returns for your portfolio.
If you have any questions about this short-term Principal Protection / Income Strategy, please reach out to your advisor.
Have a great week