Inflation and the 1970s

Bond Valuations We’ve been getting many questions about bonds and interest rates recently, so we wanted to give an update on bond prices relative to changes in interest rates. Bonds are an essential piece in a diversified investment strategy, and the best way to provide an update on bonds is by sharing data specific to this topic. In this episode, you will see a chart that shows the current price of eight of the bond indices we like to track, including corporate and government bonds. All eight are trading below par, which is the value if held to maturity. Over the past 18 months, the Federal Reserve, through its inflation fight, has raised the federal funds target rate, sending it soaring to 5.50% as of July 26, 2023. As many investors know, bond prices and yields typically move in opposite directions. Therefore, an increase or decrease in bond prices could indicate that yields have fallen or risen, respectively, over the period. Interestingly, while not captured by the time frame in the chart shown, seven of the eight bond indices referenced stood above their par values as of December 15, 2021. Current valuations have fallen below par due to the Federal Reserve raising rates. We use this chart and analysis as we manage client portfolios, and while volatility has provided an opportunity in the bond market with bonds trading below par, we know to be cautious. The Fed might not be done with raising rates; therefore, certain bonds remain under pressure. We are taking advantage of certain sectors of the bond market by purchasing bond positions below par, knowing that if held to maturity, these bonds will mature at a higher price than where we bought them. This is a dynamic we haven’t had to deal with in some time. We are seeing this impact on bond yields, the money market, CD rates, as well as other areas. We are taking advantage of bonds at a lower valuation. Not that this current interest rate environment will continue, but looking back through the history of rates, the only time that we had double-digit interest rates was in 1978-1981, which was a volatile time for bonds. We have a great opportunity here to take advantage of this while, at the same time, watching closely.   Money Supply Last month, the Federal Reserve raised interest rates again, and according to current data by the CME Fed Watch Tool, there’s only about a 30% chance of another hike for the rest of the year. These figures can change, but the dialogue will shift to when we can expect a cut. Currently, the Fed is content with maintaining rates while they perform QT before possible cuts in the first half of next year. Some may wonder why the Fed is determined to keep these elevated rates with inflation seemingly coming down. When you couple the recent commodity inflation we have seen, such as oil, gas, steel, copper, etc., with the recent turn in the money supply, you will see that the Fed simply wants to make sure they kill inflation and not re-live a 1970 reflation case. CPI, the primary inflation metric used, typically lags the money supply by 16 months. We had a historic rise in money supply during COVID due to the unprecedented stimulus provided, which led to inflation of around 9%. Since then, the money supply has been steadily decreasing and negative this year until recently. Average money supply growth in the 5% range is nothing to be concerned about. That would correlate with the 2% inflation target the Fed has set for us for years. However, if we see this supply rise rapidly again, we would be concerned about another 1970s-type reflation case. It appears the Fed is paying close attention to this, and that’s why the rate cut expectations have been pushed back until next year.       Greg Powell, CIMA®<br /> President and CEO<br />