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Everything was cruising along in the stock market until on Thursday, Fed Chair Jay Powell did what he does best, send the markets into a swoon with some significantly hawkish remarks on interest rates and inflation.
The stage was the International Monetary Fund conference in the DC swamp and Powell told the assembled throng that he wouldn’t hesitate to raise rates again if needed. Down went the S&P 500 almost 1%, up went Treasury yields on the long bond, with the two-year topping 5%.
Of course, the next day, the market popped back up, breaking through a key resistance level of 4,400. Now, it’s anyone’s guess.
These market movements underscore the most important debates going on right now on the Street: Will the economy crash or have a soft landing? Have long term interest rates peaked?
To the first question, at some level it doesn’t matter. Even if the market does not fall hard into recession, it is likely that any soft landing would entail a lengthy period of sub-par growth that would feel a lot like recession. That was the malaise we all felt at the end of Obama-Biden and as Yogi says, it’s déjà vu all over again.
Of course, in the crash scenario, the market severely corrects. In the soft-landing scenario, it still is unlikely that the stock market makes another sustained bull run. Ergo, cash is king with risk now once again to the downside.
To the second question, have the yields on the 10- and 30-year bonds peaked, we saw a very significant fallback in yields this last week, at least until Powell opened his yap. But inquiring minds want to know just why that softening of yields happened.
The benign explanation is that inflation truly is moderating. The more malign explanation is that we are witnessing a re-inversion of a yield curve that was normalizing but which now again is predicting recession.
Methinks like the first question, it may not matter which explanation is most correct. Even if gas, food, and housing prices moderate, there is still a nasty wage-price spiral we are going to have to contend with as the result of a series of lucrative labor contracts, e.g., UAW, Teamsters, UPS. This spiral will be all the more severe as long as the labor market remains tight.
One way to think about this, particularly if you are on the older side and don’t want to flirt much with stock market risk, is to park your cash in high yield short term Treasuries but also begin to “layer” into long bonds and lock in the now high returns. With layering, as yields go higher, you can add to the position – remember that in the 1970s, these yields soared to nearly 20%. So layer slowly if you do!
On a personal note here, my dear departed Mom made it solvent all the way to the grave because her husband locked in double-digit returns in the early 1980s in 30-year bonds before Reagan and Volcker broke the back of inflation and higher interest rates. Boy was it confusing to her when those bonds started to mature and her annual cash flow dropped like a rock. Still, she died happy at 94 and God bless her soul and the lesson of the long bond strategy.
As for other news moving markets, there was the disastrous Tuesday elections, disastrous, that is, if you are a Republican tired of the Democrats destroying our country. I’ll have much more to say about this in Sunday’s column. Stay tuned!
I also noted with great interest that the US housing market is now the least affordable it has been since the year of George Orwell, 1984. It now takes over 41% of the median household income to cover the interest and principal on the median-priced home.
Meanwhile, folks with low mortgages are trapped and ain’t selling. Folks that want to buy are being priced out by nearly 8 percent mortgage rates. So sales volume is anemic and the housing market is dysfunctional to say the least.
Okay, that’s it for now. Cash remains king. Watch your back!
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The problem that I see with the Federal Reserve is: Why does it need to exist? Why should interest rates be set by a committee of however many dweezers there are in the FOMC? Government bonds should be issued with a stated rate, but there should not be a rule that this rate is the market rate. If they don't get enough buyers at the stated rate, then the price drops (and the market rate increases) until they clear. Who needs a committee of "experts" to set a rate of interest?
Personnel is Trump’s Achilles heel.