Jerome Powell recently admitted that inflation is no longer transitory. I explain how stocks and bonds could be affected by the Fed’s plans to speed up tapering and then likely raise the Fed Funds Rate in 2022.
-Intro to Inflation, Interest Rates, & Bond Yields
-Higher Inflation Levels But Not 15%
-Inflation Is No Longer Transitory So It’s Taper Time!
-Interest Rate Hikes By Spring 2022?
-The Fed’s Dual Mandate Progress
-The Fed Funds Rate Affects Bond Yields, Stocks, Assets
-Real Rates Are Negative
-Jerome Powell Leads The Fed For Second Term & Effects On Bond Yields
-Why Bond Yields Move Opposite Bond Prices
-Rising Inflation Likely Leads To Rate Hikes In 2022
-Buffett Indicator & Shiller PE of S&P 500 Market Signals
In the ongoing adventures of Jerome Powell and his money printing machine, it seems like The Fed is finally coming to terms with accepting that higher than expected inflation is going to persist into 2022.
Therefore, it looks like The Fed is going to reduce its monetary stimulation of the economy (aka reduce money printing, aka reduce bond purchases, aka begin tapering) since some macroeconomic factors have recovered enough from 2020.
These factors include The Fed’s dual mandate of 1) maximum employment and 2) price stability and moderate long term interest rates, whereby the Fed manages the money supply in circulation and interest rates. The current unemployment rate of 4.2% is within the target range of what The Fed prefers of 3.5% to 4.5%. And The Fed’s preferred measure of inflation, Personal Consumption Expenditure or PCE inflation, is at 2.56% and above its target of 2%.
This is why The Fed will likely decide at their December 2021 meeting to increase tapering of the $120B/month US treasury bond and mortgage-backed securities buying it had been doing since March 2020 and could wrap up bond purchases by Spring 2022. This then sets the stage for hiking interest rates as early as Q2 2022, but it might also begin in Q3 2022 or July/September 2022 according to some economists’ estimates.
It appears many economists (and their gloriously inaccurate track record of precise predictions) are projecting there to be 2 rate hikes in 2022, but there could be between 1-3 rate hikes in 2022.
Interest rates had been nominally at near 0% (and real rates could be around -1%), but if The Fed raises interest rates that could affect the prices of bonds, stocks, and assets. Real rates in US treasury bonds have been turning negative since January 2020, and some European bond yields have been as low as -2%! Many assets’ prices have been skyrocketing in a zero interest rate environment. And some suggest that negative real interest rates are fostering more risk-taking and speculation in the markets.
It shouldn’t make sense that investors are willing to PAY money in order for the government to borrow money from investors, but maybe investors would rather have smaller losses than bigger losses if future negative real yields come into play elsewhere (like in the stock market).
When bond yields begin to invert, such as if the short term 2 year US treasury bond’s interest rates pay more than the long term 10 year US treasury bond, then that often foreshadows a recession and market decline. And while we saw inverted yield curves briefly happen in August 2019, it’s not currently happening for now.
Per some market indicators like the Buffett Indicator and Shiller PE of the S&P 500, stocks could be incredibly overvalued, so if interest rates go up then bond prices and stock market prices will likely fall as the prices of these assets are correlated. I explain how as bond yields go up then bond prices go down, and how the converse is true as well.
With the Wilshire 5000 Total Market Cap to GDP (Buffett Indicator) at 253%, that’s around 150% above the fully priced market line of 100% in Buffett’s view. The Shiller PE hit 40 in November 2021 and in December 2021 is at 38, but still pretty close to the Dot Com Bubble high of 44. These currently high market valuations appear to be justified in a low interest rate environment. But will they stay at those levels if interest rates go up? I doubt it.
I think there could be a market reckoning sooner than later, and it might not happen until 2023 or 2024, but an economic storm is looming on the horizon IMHO.
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