Over the weekend (no jog as an early Saturday walk with dog through the local college campus garnered a huge stubbed toe from a protruding curb….cannot make this up … digressing) a long ago post about the FOMC and their main enemy entered the frontal lobe…
Our September 23, 2020 Post – Federal Reserve Enemy – Inflation
“The Fed, Economics, Interest Rates and Interest Rates Review Part 2 What would force the FEDs hand?
Well covered in Part 1, here, the FOMC (Federal Open Market Committee) and Capital Markets also believe currently that interest rates will stay low for longer …. maybe we are hopeful they are both wrong (No maybe, we are!) but there is one word that we know the FOMC cannot allow to get out of control …
With inflation running persistently below this longer-run goal, the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer-term inflation expectations remain well anchored at 2 percent. From FOMC statement September 16, 2020″
The original post goes on the talk about the expansion of the balance sheet and the lack of inflation at the current time.
Fast forwarding to today, the balance sheet is unwinding and there certainly are higher inflation numbers…
If the Fed sticks to it’s word, their fears may justify continued pressure to slow an already slowing economy!
Hang tight, we have your back, but bumps may be on the horizon!
With multiple comments over the last few weeks and a pick up in headlines concerning interest rates, we decided to do an analysis and review! We also have added a video to help explain some of the complexities associated with rates and bonds … as while at face value bonds are a simple animal, their movements can be puzzling.
The main reason for the increased headlines and comments are when rates go up, the value of bonds goes down initially, and rates have really jumped dramatically for various reasons.
Briefly as a reminder, Bond aka Fixed Income aka corporates aka treasuries aka high yield aka Fixed Income instruments are nothing more than a note with an income stream to the purchaser of the bond! There is a saying the bond market is “Smart” because you only have to worry about the ability and willingness of the lender to pay… nothing else…
Rates and Bonds – I Go Up, You Go Down
The Green line is the yield on the 10 year treasury… The red is a huge bond fund from Vanguard called the BND….
No doubt that this is an almost perfect inverse relationship.
One detail worth mentioning, longer term bonds are more volatile, both up and down than shorter term i.e. A one year bond will not move near as much as a 30 year. This makes sense because the longer the term, the more payments that are owed and the more change in the prevailing rate effects the bond.
Fast Fast Fast Movement
In true, be careful what you ask for fashion, (we have long been positive towards higher interest rates) rates have moved incredibly fast, especially Mortgage Back Securities which are pools of mortgages used for determining current new rates…
This is the average 30 year fixed rate mortgage…. as of yesterday, this rate was well over 5%…this rate is almost double the rate just a few quarters ago…. With eventual supply, our home asset is facing some headwinds !
Much of this rate movement is coming from Federal Reserve Bank Presidents public comments…..
Why would they do this? To slow the economy… if they can get the market to move rates up, their job is easier ….heck if they can get market participants to do all the work, the Fed would hardly need to do anything… plus markets are much faster to react than the FOMC (Federal Open Market Committee)
Once interest rates move, a new bigger income stream is the net effect… New purchases or re-investments are met with bigger income payments…
This continued higher income payment begins paying back the headwind of the drop in value as shown in the first chart…
Clipping that coupon will be nicer as rates increase!
How Far Can they Go? Rates and the FOMC?
Here comes is the sizzle…. be careful on extrapolating higher rates into the future… this extrapolation has garnered a lot of headlines as of late …. Whoaaaa
This is about a 35 year chart… go back farther, to a much younger demographic, there was a time when the FOMC raised interest rates to the roof… think 15-18% to tamp out inflation….
With an economy today of much more debt to service and older (more savers, less spender) demographics the last four decades have been a slow but continued lower longer term rate….
Note the top of the prior interest rate cycle looks like the top of the FOMC rate hike…again the last four decades….
With the afore mentioned cycle high repeating as the following cap on rates, looks like, although very fast rate movement recently, the majority of the move is likely over….and therefore less headwind for the value of bonds and bigger coupons….
Lastly… a slowdown in economic times or a rush for the safety of our simple friends usually leads to a reversal in rates and a repeat of the afore mentioned process…but in reverse… lower rates, higher prices!
Have a Great “Bonds and Interest Rate Analysis” Day!
With a tremendous amount of attention being paid to the Bureau of Labor Statistics CPI Report (Consumer Price Index), we set off as part of our research to find an easy explanation of the breakdown of the index.
As a reminder the CPI index is a measure of inflation, hence the increase rhetoric not only in the public domain, but here as well, as we have spoken about it multiple times via analysis.
Back to the analysis, we found tons of information about the make up of the aforementioned CPI index, and a 100 plus items that make it up, but oddly it took us some time to find the true easy breakdown in larger macro elements of the CPI index.
Great news, a new approved non-copyright use from a fantastic new research service called Pew Research has been discovered. With approval from their public relations folks, we are happy to finally show you this wonderful graph that breaks the CPI index down into very easy and visually friendly context.
We will be referring back to this graph frequently, as some of our future commentary will be about this CPI index, and what it may look like in the future and what it means from a Federal Reserve/FOMC standpoint.
We have been hearing of rent increases, but did not have a great way to track it. After running across the fantastic Apartment site at www.apartmentlist.com, which has over 5 million apartments and counting for rent, and they are collecting data.
The following is the National Average from 2017 to present. More specific geographic areas are available, but we wanted to use the broadest measure.
Rising rent costs are an understatement, the move from the beginning of the year is approaching 30%…. yep a 30% increase in rent, NATIONWIDE
With Shelter being such a large portion of not only the CPI, but many families expenses, this is worth watching closely!
Warning: Financial Bottlenecks are ….. well getting MORE bottlenecked
Do not procrastinate on transactions, especially ones planned, like donations, tax issues, account adjustments or necessary known in advance needed movement of money…
Do it now and avoid the stress if at all possible!
Ok, back to our regularly scheduled, a bit heavy Friday Post: FHFA Stunning Value Increase
A conforming or NON-jumbo Mortgage loan tends to have easier qualification terms, lower rates and lower down payment options … Of course each situation is different, but just on the normal margin, the preceding tends to be true…
On a side note, just really enjoy the connections of the dots via our Government Agencies…OK, Digressing…
FOR IMMEDIATE RELEASE11/30/2021
Washington, D.C. – The Federal Housing Finance Agency (FHFA) today announced the conforming loan limits (CLLs) for mortgages to be acquired by Fannie Mae and Freddie Mac (the Enterprises) in 2022. In most of the U.S., the 2022 CLL for one-unit properties will be $647,200, an increase of $98,950 from $548,250 in 2021.
Prior Year Release of 7.5%
Fannie Mae and Freddie Mac Baseline Limit Will Increase to $548,250
FOR IMMEDIATE RELEASE11/24/2020
Washington, D.C. – The Federal Housing Finance Agency (FHFA) today announced the maximum conforming loan limits for mortgages to be acquired by Fannie Mae and Freddie Mac in 2021. In most of the U.S., the 2021 maximum conforming loan limit (CLL) for one-unit properties will be $548,250, an increase from $510,400 in 2020.
Great for homeowners as they fight higher prices
Especially for possible new young homeowners that would not have otherwise qualified
Possible, another, not cheap asset class
Did not mean to get all heavy on a Friday, but thought it worth noting……
Have a Great Friday, Super Weekend and Talk Next Week!
IRS Refunds and Tax Return Processing Very Delayed
In this Break In Post, after having discussions with several of you, and then touching our CPA contacts we came to the conclusion that the IRS is delayed in processing returns and more importantly REFUNDS!!!
Before we could get the news to you, this Yahoo Finance Article nicely summarizes that the IRS is behind on a whopping 20% of returns or over 30 million !
With a September 1, 2021 IRS stimulus check lookback (those who did not get the last round of stimulus will be reviewed by the IRS to see if they qualify) the IRS has their hands very full….
All together…. PATIENCE! They will eventually get to us!
Fingers Crossed For a Hot (Large) COLA Increase
Catching wind through our contacts of a possible HOT (read Large!) COLA adjustment this year for Social Security and possibly those lucky ones that have a COLA adjuster on their Pension or other retirement plan we dug in here in this post and outlined the methodology used by the SSA. The line in the sand for adjustment is later in the year but as can be seen by the latest CPI-W running at 6.1%, with a little luck, we may have a very nice adjustment on our hands!
Capital Market Comments
Valuations are Getting Better but Expectations are WAY out of Line!
In this post and with the help of our Friends at JPMorgan we happily reviewed the far right hand smartly turning graph, that is headed in the correct direction for better valuations… YAY
A bit later in the month we ran across a wonderful but somewhat worrisome poll done by Natixis of over 8000 investors and their expected return over the next 10 years…. Way off base in our minds….
Likely to see this last poll make its way into the Newsletter as these numbers are likely so exaggerated, we want more air time!
Ok…that’s a wrap for the July review….
Have a Great Day, Talk to You at the End of August!
With hindsight available as our measuring stick, it appears that sometime between March and April earlier this year things across the country really began to return to some type of normal.
As noted in our blog at street-cents.com and in the prior newsletter TSA throughput a measurement of airport travel looks to possibly eclipse 2019 highs later this year.
Restaurants began opening, some earlier and some much later, depending on the geographic location with patrons welcoming their reopening.
Uncertainty remains on the remote versus office environment. Most think the new normal will not be a complete office environment, but some blend of remote since it is readily acceptable and well tested.
Inflation, Here to Stay or Transitory?
As discussed in detail in our latest Q 3 2021 Newsletter, the most prevalent debate at this moment among market participants is the topic of inflation and it’s staying power, or just transitioning through. The importance of this subject is directly related to the FOMC, chaired by Jerome Powell and the timing of his reduced stimulus. All eyes are on the inflation debate and the timing of the decrease in stimulus and will be sensitive to timing changes.
Not surprisingly economic numbers roared as they met favorable comparisons from last year, but in very recent days, have given the appearance of a return to normalcy already, decreasing concerns of longer-term inflation.
Capital Markets being forward looking are now trying to see what is around the next corner. As earnings continue to return to normal, valuations are finally beginning to be decreased from extremely stretched proportions and as long as earnings outpace returns a continuation of this should occur.
Time is really our friend, and once again the good news is, this will all play out in quarters rather than years. Things can certainly change quickly, and it is not a time to swing for the fences, which we never do!
Have a terrific summer and talk to you at the beginning of fall.
Murphy’s law being applied, the form just arrived last week….about two weeks after our post…..
Reason for receipt:
Rollover of a 401k or the like to an IRA – Most frequent
Contribution to an IRA
Contribution to a SEP
One of the most confusing parts of this form is that even though you may have made a qualified contribution for a prior year i.e. 2020, if you made that contribution in 2021, depending on the type of contribution the Form 5498 MAY show your contribution in year 2021.
Capital Market Comments
Inflation or No Inflation
In this part two post, “The Smartest Guys in the Room” post we discussed via interest rate futures graphs the movement after FOMC dot plot adjustments and the interest rate markets….
This is an updated Graph of the 2 year US Treasury, which is holding lower, (higher yield) possibly due to faster expected rate increases!
This is the ultra long 30 Year Treasury, which continues to trend higher (lower Yield) possible pricing less inflation from the above mentioned expected shorter term rate increases!
Ok…that’s a wrap for the June review…. Hello July!
With this post already set to go, I ran across this interesting chart late in the weekend and thought it worth adding- looks like others are interested in at least the Inflation answer: 2004 to current Google Trends Searches –
Blue = Inflation Searches
Red = Deflation
Yellow = Recession
Ok, back to our regularly schedule Post!
n spring of 2020 during the beginning of the countrywide lockdown‘s we had the opportunity to attend a conference that we had never chosen to do before due to logistics, cost, and length of the conference (7-10 days). John Mauldin SIC Strategic Investor Conference, after 18 years of consecutive conferences Mauldin shifted last year’s and this year’s conference to virtual and we were happy attendees.
The conference this year lasted a total of two weeks and had 45 speakers of which about 35 were Capital Market related with the other 10 being macro-economic or specific industry such as doctors.
Views: Number One From the Conference – Go Away FOMC – You Have Stayed Too Long
View number one and shared by every market related expert, the federal reserve is overstaying their welcome and should immediately stop asset purchases and begin talking about increasing rates. The main reason for these shared views are because asset levels have become inflated across almost all assets according to the experts and be continued purchases are no longer necessary given that capital markets are orderly.
Number Two – Inflation Is Coming – Via Jim Bianco
View number two shared by approximately 75% to 80% of the Capital Market Professionals were there will be some type of inflation. About half of the professionals felt like inflation would indeed be transition, which is what Jerome Powell (FOMC President) and the federal reserve are saying the other half felt like by the FED continuing to purchase assets a change from the long deflationary era of the last four decades to a longer-term inflationary era over the next several decades is ahead.
None of the pro inflation experts predicted runaway inflation that we had in the 70s but the most aggressive inflationary person that we heard was Jim Bianco of Bianco research. In one of many slides, Bianco pointed to the rise of the 10 Year Treasury, below and a belief it would continue to rise.
Number Three – No Inflation, Back to Slow Grow – Via Lacy Hunt
View number three, shared by the remaining market experts emphatically, there will be no inflation and we will return to a slow growth environment similar to what we had coming out of the financial setback of 2007 -2009.
The most emphatic believer of this deflationary trend was Lacey Hunt who oddly enough shared the stage with the aforementioned Jim Bianco, and has been an expert in the capital markets for 40 years.
Mr. Hunt‘s main beliefs on why deflation will continue are the debt occurring by the afore mentioned FED asset purchase and ageing demographics.
So what are we do with all of this information and where does that leave us?
With such dissenting opinions it’s clear that someone will be wrong and things never work out exactly like people think, so some may be correct in a portion of their view an incorrect and another.
If Bianco is correct and inflation occurs and remains this would lead to substantial pressure on long duration assets such as the value of real estate, low earning but fast growing equities, long bonds such as the 30 year treasury and higher borrowing costs across the board. This would be a dramatic change from the last four decades and more rhyming of the late 70’s, but again not to the extreme.
If Hunt is correct, this will be a continuation of what we have seen over the prior four decades. Lower long term rates, lower borrowing costs, continued slower economic growth, lower expected earnings and continued upward pressure(tailwind) on the above mentioned longer duration assets.
The good news in monitoring each of the various forecasts we have easy to read and follow economic numbers such as the CPI and the level of interest rates, as well as federal reserve speakers talk in public venues.
In closing all of professionals believe most asset prices were elevated. High asset prices are not a direct reason for them to come down, and elevated asset prices can be grown into, like the 13-year-old growing quickly into the 15-year-old clothes. But high asset prices demand discipline and care as increased volatility is likely.
Have a Great “Inflation Deflation Tug Of War” Day!
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investments may be appropriate for you, please consult your financial advisor prior to investing!
The is the vocal portion of J.K. Financial, Inc. a Dallas Texas Based Fee Only Total Wealth Financial Planning Firm. Founded by John Kvale, a Dallas Texas Fee only Financial Planner and Total Wealth Manager.