I hope you are all doing well. The major U.S. stock indexes posted weekly gains of 6% to 8% to recover all the ground lost in the preceding two weekly declines. It was the strongest weekly result since November 2020 for the S&P 500, the NASDAQ, and the Dow. The rally in stocks can be attributed to near-term oversold conditions, more clarity around the future interest rate path, and the fact that the bond market was already pricing in aggressive Fed tightening. Emilio Delgado (Luis, the fix it shop owner on Sesame Street) passed away this week. I have broken down this week’s news using quotes from Sesame Street.
The U.S. Federal Reserve raised interest rates for the first time since 2018, following through on market expectations to lift its benchmark lending rate by a quarter of a percentage point to a range of 0.25% to 0.50%. Looking ahead, policymakers indicated they’re inclined to raise rates at each of their six remaining policy meetings scheduled through the end of 2022. Meaning seven rate hikes in 2022. The Fed would prefer to see inflation ease through growing supply and clearing bottlenecks. But they’re no longer willing to wait for this to happen, fearing high price pressures might become entrenched. By raising the cost of money over the next two years, the central bank hopes to guide inflation down by slowing demand to align it with supply.
At this moment, amid a rising-rate environment and high inflation, bonds continue to be the most unpleasant place to be invested. Prices of government bonds fell, sending yields sharply higher for the second week in a row. The yield of the 10-year U.S. Treasury bonds climbed to about 2.15% on Friday—the highest level in nearly three years, and up from 1.73% just two weeks earlier. Does that mean the bank will finally give you some interest on your deposits? Unfortunately, no, yields on cash will not initially move in tandem with the Fed rate increases. Banks are flush with deposits and have little incentive to raise the interest they pay until loan growth picks up more meaningfully. Mortgage rates, which are more closely tied to the 10-year Treasury, will also probably move higher, likely cooling the housing market. Finally, rising yields may continue to challenge bond returns. Bonds usually play the important part of acting as a portfolio stabilizer during times of stock market volatility. They are less equipped to do so at this point and I continue to prefer other fixed income assets like annuities for the stable piece of your portfolio.
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