The Fed is Waking Up and Is putting its foot on the brakes!

“Hindsight says we should have moved earlier. . . . But there really is no precedent for this.”  Fed Chair Powell, March 3, 2022

The Yield Curve inverting has been the most accurate predictor of the economy tipping into a recession for the last 50 years. Typically, it takes about 6 months from the time the Yield Curve inverts for a recession to kick in. So, what exactly does an "inversion of the yield curve" mean? An inversion of the yield curve is looking at and referring to the differences in interest rates being charged by banks over a 2 and 10 year lending horizon. Economists also look at the 3 and 10 year lending rates as well.

Typically banks will charge a lower interest for a short term loan than for a longer term loan. Banks are incentivized to lend out at higher interest rates over a longer term loan period. However, when the 10 year interest lending rate is less than the 2 year lending rate, banks have less incentive to lend. This is known as the "yield curve inversion" when the longer term 10 year lending rate is less than than the 2-year rate. It does not happen often but when it does, it has been a good predictor of an upcoming recession for over 50 years. 

The spread between 10-year and 2-year Treasuries has fallen from 0.89% in early January to just 0.18% on March 21. So while we are close, we are not there yet.

If you are walking into The French Laundry, a 3 star michelin restaurant in Napa, you may well expect to pay $50 plus for a sandwich extraordinaire. Not so, when you walk into your average sandwich place. I almost fell out of my chair when the person cutting my hair told me she was going to be charged $50 for a chicken sandwich at a local eatery in Walnut Creek, La Fontaine. She had paid $20 for a sandwich one day, $30 the next and then a few days later was presented with the $50 price tag. She declined the sandwich. 

While this may be an extraordinary tale of sandwich inflation and who knows what else, the reality is that the cost of eating out has gone up significantly, but this is sandwich madness. Yes, Russia and Ukraine are two of the largest exporters of wheat and there will be supply shortages that impact prices worldwide. The Russia-Ukraine situation has also sent gas prices soaring. Gas prices have risen to some of the highest in recent USA history. However, has America stopped growing its own wheat and raising it's own chickens? Of course not. So, why is a local sandwich shop in Walnut Creek charging $50 for a chicken sandwich? Is it the best chicken sandwich in Walnut Creek? Probably not.

The supply chain issues have given opportunity for corporate and business greed to inflate as well. While some price increases may be justified, of course, some price increases across a range of industries ranging from 50-500% are quite litterally "out of this world" and unjustified by any rational commercial standards.

We first want to wish all our readers and clients a Happy New Year!

As we say goodbye to a tumultous 2021, we look forward and to 2022 and what it may have in store for investors. 2021 saw inflation run away to heights not seen for decades. The Fed completely under-estimated this and shifted gears stating it was going to get serious about tackling inflation by tapering its bond buying and raising interest rates in 2022. The markets are re-calibrating. How big an issue is "inflation" and how soon can it be brought under control? These are the key questions as they will influence how aggressive the Fed is with respect to raising interest rates.

The key determining factors with respect to taming inflation are:

We have often written about the "asset inflation" bubble caused by a trifecta of near zero interest rates, record levels of money printing not seen in american history and the federal reserve acting as a backstop for everything! Well maybe not everything, but again more than ever before. The "relative value" of the dollar continues to fall against this backdrop. a trend that has continued over a 50+ year period. The purchasing power of the dollar has fallen by 92% over the last 50 years. Let that sink in for a moment. The only saving grace is that other westernized countries are not faring much better yet none have the size of national debt of the USA. It helps to be the worlds reserve currency!

In the midst of a historic "asset bubble" of "everything" where many fund managers are cautious, there are well respected fund managers talking about a continuation of the bull market into 2038, one that is fueled by the "millennial" generation. The arguments are compelling and we wanted to share some of them in this article.

Cathie Wood, the architect of Ark’s comprehensive range of ETF's sais: “So this is the echo of the baby boom,” in reference to the millennial investors being the new drivers of an extended bull market into 2038 to mirror the baby boomers who fueled a 20-year bull market in stocks during the 1980's and 1990's.