by Blaine Dickason
Senior Vice President
Trading and Fixed Income Portfolio Management
The Federal Reserve has maintained near-zero interest rates for nearly two years, and by now, it is clear this extraordinary policy is no longer needed. Over the last several months, continued elevated inflation readings, coupled with a tightening labor market, have led the Fed to suggest rate hikes are coming both sooner and faster than previously expected. Next week’s meeting of the rate-setting Federal Open Market Committee, and the subsequent press conference with Fed Chair Jerome Powell, should provide more clarity on the Fed’s plan to begin raising interest rates, as our central bank embarks on a new rate-hike cycle.
In addition to slashing the overnight Federal Funds rate to zero at the outset of the pandemic, the Federal Reserve also conducted large-scale bond buying that will finally conclude by this March. This use of the Fed’s balance sheet has kept longer-term interest rates lower than they would ordinarily be, thereby reducing the cost of borrowing for millions of consumers and businesses. After those net new purchases conclude, the Fed may also decide to let prior bond purchases roll off without reinvestment, limiting their downward influence on longer-term interest rates. This reduction of outright bond holdings is called ‘quantitative tightening’ and should provide an upward bias to longer-term rates.
History may not always repeat, but as the saying goes, it often rhymes. We’ve looked back over the last four rate hike cycles, and as you can see from the table below, the S&P 500 performance over these four periods was positive in all cases. Underneath the surface however, we do believe the changing interest rate environment will lead to performance dispersion across asset classes. Some sectors, like cyclicals, real assets and financials can actually benefit from rising rates and prices, while higher rates are a headwind for fixed income holdings. Our current investment allocations across stocks, bonds and alternative income reflect this outlook.
Source: Bloomberg
The commencement of a new rate hike cycle is an explicit endorsement of economic strength. The Federal Reserve’s policy toolbox is largely limited to influencing the demand side of the economy, so until the supply side of the economy can fully repair itself, expect the Federal Reserve to address elevated inflation by reining in the unprecedented stimulus heaped upon the economy over the last two years. We continue to expect inflation to moderate and approach its historic average of 3% as we move through 2022. After an extraordinary period of economic data and subsequent policy responses, we look forward to this economic return to ordinary.
Week in Review and our Takeaways:
“Stay at Home” bellwether stocks Netflix and Peloton have had a bad last 12 months, trading down -31% and -83% from their respective year-ago levels
Of the 64 companies in the S&P 500 that have reported Q4 2021 results through yesterday, 76.6% have reported earnings above analyst estimates. This compares to a long-term average of 65.9% and prior four quarter average of 83.9%