Is Jay Your Pal (Powell)?
“Choice without alternative is only a sleight of hand, it is a magician’s force-play during which you believe you have free will, but your fate has already been decided.” – Garth Stein
Federal Reserve Chairman Jerome (Jay) Powell certainly left no chance for misunderstanding on where he stood on incarcerating our country’s least wanted intruder, inflation. Speaking at a meeting of the International Monetary Fund (IMF) on April 25th the estimable chairman offered up these comments. “Getting inflation back to the 2% goal is a critical policy imperative right now. It is absolutely essential to get price stability…”. True to his words the Federal Reserve increased interest rates by ½% on May 4th with some believing that another ¾% may be forthcoming at the conclusion of their next meeting on June 15th. These folks are serious!
The stock market year to date has been an unhappy companion on this journey towards placing the inflation genie back into his jar, closing out the month -12.8% year to date with the 10 Year US Treasury rate having started the year at 1.52% reaching 2.83% at month’s end. Still, if one peels back the veneer of the seeming reality created by those numbers, something VERY interesting is happening beneath the surface.
If the trade weighted value of the US Dollar acts as a thermometer measuring the health of the global economy, the patient has been in a feverish condition most of the year having risen by 9.5% by May 12th. That increase has since diminished to 6.4%. The S&P 500, which was down 5.5% for the month on May 19th, closed the month eking out a +.2% return. Perhaps most interestingly still, the 2 Year US Treasury rate, which had risen to 2.78% by May 3rd finished the month at 2.47%. So, when it comes to the future direction of interest rates, do the financial markets know something that Jay Powell doesn’t know, or at least is not saying? And does this explain the recent recovery in the stock market and the decline in the value of the US Dollar? Stay tuned.
The size of the US federal government debt just passed a nice round number this past month. $30 trillion. In 2021 the US Treasury spent $400 billion paying the interest on that debt at an average interest rate of 1.5%. At current rates that level would be near 3%. If The Fed raises interest rates to sufficient levels to push the country into recession, tax revenues go down appreciably, the deficit widens and the government needs to issue increasing volumes of debt at higher interest rates. Is this REALLY what “uncle” wants? Could “uncle” actually want perhaps a bit of a whiff of inflation to devalue that $30 trillion (and growing) while holding interest rates at levels that “uncle” can afford to pay? Is this “the sleight of hand” that the financial markets are starting to see with the resulting “hawkish” talk of The Fed but “the dovish” walk of the bond market?
Financial market commentators have begun to ask “does the Federal Reserve still love the S&P 500?” remembering fondly those days of yore when every banana peel the stock market would encounter on its journey to steadily higher levels would be met by “the cavalry” of another interest rate cut by the Federal Reserve. Investors should reassure themselves that the answer is most assuredly YES! though not perhaps for the reasons they suspect. An increasing percentage of income taxes are being paid by the wealthier cohort of our fellow citizens and a very large share of their “contributions” are not derived from ordinary income but rather from the realization of capital gains. It is interesting to look at a chart of the rise and fall of tax receipts and the year over year rate of return of the S&P 500. Rest assured. The US Government does care about the stock market.
It has been a challenging year for investors with very little in the way of “safe harbors” to preserve capital with the S&P -12.8% year to date and with interest rates having risen even the bond index (AGG) -9.3%. 60/40 stock/ fixed income investors are looking at losses of approximately 12%. Those losses have narrowed modestly the past several weeks but still investors wonder whether this will get worse and when will the financial markets start to rise rather than fall. The days since May 19th hopefully offer a harbinger of the better days to come with the S&P having risen 6% since then. We’re looking forward to better news in the months that follow!
Mark H. Tekamp, June 3, 2022