April 10, 2022

The Fed vs. Everybody

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Bottom Line:


Fed officials keep flooding the airwaves with aggressively hawkish commentary in a bid to talk up rates. This week, Bullard advocated for a Fed Funds rate a full 3% higher by year end, ex-President Dudley pleaded with the Fed to “inflict more losses” on bond and stockholders, and the FOMC minutes outlined a potential $95 billion monthly pace of quantitative tightening. It is working. 10-year Treasury bonds now yield 2.7% and 30-year mortgages now cost 5%. The Fed may be behind the curve on policy, but it is on point conversationally. With the future so uncertain, it’s much easier for the Fed to eat its words than reverse its policy, making all this tough talk not only effective, but also strategically sound. For investors, higher rate cycles typically accompany lower valuations, making lower valuation portfolios also strategically sound.


The Full Story:


The Fed continued their vociferous bully tactics against inflation expectations this week. The release of minutes from the last Fed meeting revealed near consensus on raising rates .50% but-for-Ukraine and a strategy for shrinking their $9 trillion balance sheet by $95 billion starting in May. This onslaught of tough talk and policy signaling have driven market rates dramatically higher. The 10-year Treasury bond yield has vaulted up from 1.5% at the beginning of the year to 2.73% today, while the 30-year mortgage rate has hurtled to 5% from 3% to begin the year. This has led to significant pressure on equity and bond valuations and a 40% decline recently in mortgage applications. Since quantitative tightening targets increased long-term rates, the prospect of more rapid and significant bond sales has also led to an un-inversion of the yield curve. Kudos to the Fed for meaningfully tightening monetary policy while un-inverting the yield curve, with only one rate hike!


The more the Fed can accomplish via “conversational” tightening, the less “actual” tightening they will need to do. While the current policy rate sits at .5%, the futures now forecast rates of 2.5% before year end:


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The Fed has yet to shrink their $9 trillion balance sheet, but traders now expect the Fed to shrink its balance sheet by $2 trillion+ over the next two years, three times the pace the Fed tightened in 2018. To punish investor sentiment even further, former NY Fed President Bill Dudley espoused Wednesday that the Federal Reserve will need to inflict “more losses” on the stock and bond markets to meaningfully rein in inflation. For those who argue that Fed policy has fallen far behind the curve, that may be true, but Fed speak has rapidly caught up, and so have interest rates.


The Fed’s campaign to talk rates up has been the most aggressive on record, and it’s working precisely as designed. Longer term inflation expectation measures remain cozy with the Fed’s 2% target and near-term measures have come off boil. By tightening without tightening, the Fed has availed itself of much greater policy flexibility. Should the economy stall or inflation cool, removing tough talk will be far easier than removing rate hikes or reversing quantitative tightening. Investors may not like what they are hearing, but it’s far more benign to markets than the actual doing.


Style Check


I review “pure style” indices frequently for exaggerated style performance distinctions. The pure style indices contain the growthiest of growth stocks and the valueiest of value stocks. In theory, a rising rate environment should adversely impact higher P/E “growth” stocks more than lower P/E “value” stocks. With rates rising dramatically, the performance differentials should also be dramatic. Let’s check:


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True to text, investors equally weighted across the three pure value indices have seen declines of .5% on the year while investors equally weighted across the three pure growth indices have seen declines of 16%. Recall that the situationally low P/E’s across Europe and the emerging markets confer value status on them as well. Year to date, Europe (ticker: IEV) and the emerging markets (ticker: EEM) have each fallen 8% despite war in Europe and Russia’s inclusion and elimination from the emerging market index. This analysis supports our global value bias and our contention that Powell matters more than Putin to markets.


Have a great Sunday!



David S. Waddell 
CEO, Chief Investment Strategist




Sources: Bloomberg, Morningstar




David Waddell
Author: CEO Chief Investment StrategistAfter graduating from the University of the South with a BA in Economics, David began his career with Charles Schwab & Co., Inc. in Phoenix, AZ. Having been recognized for his outstanding business development record, David was promoted to the San Francisco- based Institutional Strategic Accounts Team, which interfaced with the Big 5 accounting firms and Schwab’s largest customers. David left Schwab to continue his education at the graduate level in Boston. While earning his MBA degree with a concentration in finance and investments at the F.W. Olin School at Babson College, he was appointed by the college Trustees to manage a team of seven portfolio managers overseeing the student-managed portion of Babson’s endowment fund. David also founded the Babson Investment Management Association to assist undergraduate and graduate students with training and career path planning in the investment management field. As the firm’s Chief Investment Officer, David chairs the W&A investment committee and combines macro economic forecasting, macro market analysis and macro risk assessments to design portfolio strategies utilizing public market securities worldwide. A civic leader in Memphis, David currently acts as Chairman of Epicenter Memphis, and Co-Chair of the Memphis Chamber Chairman’s Circle while also serving as a board member for LaunchTN and the New Memphis Institute. David previously served as chairman for The Leadership Academy, the RISE Foundation, and the Economic Club of Memphis. He also chaired the capital campaign to build the “Live” stage at the Memphis Botanic Garden. David was a member of the 2004 Leadership Memphis class and has been recognized as one of Memphis’ “Top 40 under 40” by the Memphis Business Journal, and as a finalist for “Executive of the Year” in 2007. In addition to weekly columns in the Memphis Daily News and the Nashville Ledger, David has appeared in the Wall Street Journal, USA Today, Forbes, Business Week, Investment News, Institutional Investor News, The Tennessean and Memphis Business Journal. He has also made appearances on Fox Business News, Yahoo Finance, Bloomberg TV, CNBC, and CBS News and ABC News Channels. Read some of David's articles on his author page in Inside Memphis Business. David has two wonderful children, Easton and Saylor, an obedient Labradoodle named NASDAQ, and a devoted Goldendoodle named Ripley.


David S. Waddell


Chief Investment Strategist

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