• STEPHEN: The Fed just hiked interest rates again, the stock market has been under pressure, and inflation, well, what’s going on with inflation? Thanks for tuning in to another episode of “The Smart Money Show.” I’m your host, Stephen Rischall, along with my cohost today, Chris Carter.
• We’ve got a lot to unpack in today’s episode. We know the Fed last week, Jerome Powell just spoke and raised interest rates yet again. So we’ve seen that Fed funds rate go up quite a bit, quite fast so far this year. Chris, what do you make of all this Fed speak and what’s going on?
• CHRIS: Yeah, just a quick recap of what happened last week. So the Fed, as you mentioned, Stephen, did raise interest rates by another 0.75%, and they indicated that they’re going to keep hiking well above the current level. So the latest increase now brings the Fed’s main policy rate up to a range of 3% to 3.25% which is the highest since early 2008.
• So, you know, that comes after recent CPI data came in a lot hotter than expected. But more important than the latest rate increase, is the message that the Fed sent about where rates are heading. They released their economic projections, including what they call the dot plot, which suggests that they intend to continue to hike rates until they hit what they refer to as a terminal rate or endpoint of 4.6% in 2023.
• The Fed is signaling that they intend to, you know, leave rates relatively high for longer than a lot of people, including investors, expected. This implies in the short term another 1.25% point rate increase this year. So most likely, 0.75 in November and another 0.5 in December.
• STEPHEN: Wow, so it seems like the Fed might raise rates a bit more. But what do you think about that, Chris? Do you really think the Fed is going to continue raising rates at this pace towards the end of the year?
• We’ve seen a lot of destruction so far in the stock market. We’ve seen real estate come down. It definitely seems like the economy has slowed down, which is what the Fed wanted. Do you really think they’re going to keep moving this quickly or do you think they might taper off a little bit towards the end of the year?
• CHRIS: Yeah, that’s the question of the day. That’s what everyone on Wall Street, economists are weighing is, are they being too aggressive? You know, earlier this year, many people thought that the Fed was a little late and they weren’t fighting inflation aggressively enough by raising rates quicker than they did. So now, the opposite seems to be happening. Is the Fed too aggressive? And the idea that, you know, increased rates will slow the economy and lower inflation, but the results take time to happen.
• It can take months or even up to a year for these rate hikes to really work their way through the economy. So, you know, the very aggressive rate hikes are happening, and look like they’ll continue to happen, but you know, the policy makers may not be allowing time to see the effects of the monetary tightening on the economy. So, we’ll see.
• They keep wanting to have this soft landing, as they call it, but, without throwing us into a recession, that seems harder and harder. So we’ll see what happens, but that is the topic of the day. At this point, they do seem pretty firm about keeping rates on that path to go higher.
• STEPHEN: Right, and look, there’s a good and a bad sides to rates. On one hand, it increases the cost of borrowing, and like we said, it slows down economic activity across the board, business loans, mortgages, home equity lines.
• I thought it was really interesting, Chris, we looked at the chart of the federal funds rate and how that’s increased, but we overlaid that with 30-year mortgage rates, the average 30-year mortgage rate. I know in speaking with a lot of clients recently, they are saying, “Wow, mortgages are so high now.” And I think that’s all relative.
• If we look over the last 10 years, we can agree that mortgages have been historically low. The truth is, over the last 20, 30, 40 years, much longer periods of time, an average mortgage rate here in the United States on a 30-year fixed mortgage, it’s been in that 5% to 6% plus range.
• CHRIS: Yeah, there’s certainly some recency bias, right, with a lot of things, but certainly, mortgage rates and well, you know, any of us who refinanced or purchased a home towards the end of last year, you know, you were getting under 3% rates, which, you know, really is absurdly low.
• And to your point, you know, we’re back to a level that is more normal, but that doesn’t mean that the pain of someone who’s looking to buy a house, especially their first home, you know, those increased mortgage rates have really thrown their affordability, that’s kind of been really hard for them to juggle that. So, you know, we’re starting to see, especially here on the West Coast and in Florida, you’re starting to see the housing market really starting to cool, and you know, the other parts of the country will follow.
• STEPHEN: Precisely, I think that’s definitely the case. And you know, it leads us into, we keep hearing on the news, recession, recession. We’ve been talking about for awhile that frankly, it seems like we’ve already been in a recession. You know, the last two quarters have been negative GDP growth, so historically, that’s been a way that you sort of gauge if you’re in a recessionary environment or not. The market’s clearly already spoken. We’ve seen asset prices, real estate prices, everything’s come off of those peaks 10%, 20% or more.
• And that’s a big thing. I think that’s weighing heavily on investors’ psyches. People are worried. You know, “Hey, should I throw in the towel now?” Definitely now is not the time to do that. It’s typically times like these where we look back 3, 5, 10 years from now and say, “Man, you know, that would’ve been a really good opportunity to invest when prices were a bit lower.”
• Now that doesn’t mean you should necessarily do that. It depends on your situation, of course, and your time horizon. And I think we can all expect that there’s more volatility, at least in the short term, especially as we come up on, elections at the end of the year here, midterm elections in November.
• And still, like you said earlier, Chris, inflation, I think we should take a moment to talk about inflation. Because we’ve discussed how important of a key factor that is and with rising inflation over the last year, year and a half, that’s been a big concern for investors. But that number has been going down, right, Chris? I mean, the last two months, we actually saw what we would call more normal numbers.
• CHRIS: Right, right, and the, so, the rate hikes, you know, come with the hopes that the headline inflation’s gonna drift down. And as you can see, at least the past couple months, the month-over-month rates have kinda reverted back to a more normal level. And so, now the Fed is, you know, they’re projecting by 2025, that they’ll get down to their 2% target.
• We’ll see, but you know what’s interesting also about inflation, Stephen, you and I were talking the other day and you had a really good point about, you know, higher inflation and, you know, its impact on government debt.
• STEPHEN: Yeah, you know, I was hearing an economist speak about that and there’s two things that stick out to me. When inflation is high, especially when it’s high quickly in a surprising fashion, it can make it easier for governments to pay down their debt.
• So I think one thing to keep in mind is, higher inflation actually increases tax revenues, right? If we’re all earning more money, then we have more money that’s getting taxed at those same tax thresholds, income tax thresholds. Not to mention sales tax and everything else, maybe, at a local level in your state or municipality. So you’ve got increased revenues that are going back to the government. That’s one side of the coin.
• The other one as we’ve seen, I mean, bond investors have been hurt quite a bit this year, but higher interest rates mean there’s better yielding bonds out there, the bonds that were already sold previously and that investors already hold, those are now worth less. Meaning it’s a lower cost, it’s cheaper for governments to pay down that debt, so the real value, right, the nominal value of debt is reduced in times of inflation. So, that’s maybe good for the short term.
• We have GDP as a percentage of debt. You know, we’re finally seeing that number come down, which is a positive thing. For years, we’ve been talking about how debt is increasing, increasing, increasing as a percentage of GDP. That’s maybe a silver lining. But at the same time, we can’t just inflate ourselves out of a recession here. That does come at a cost potentially. Who knows, Chris, 5 to 10 years from now, that might be the next thing we’re talking about after this eventual recovery, right?
• CHRIS: Right, yeah, the inflation, you know, it makes the old debt easier to pay off, but it makes the new debt more expensive. So, yeah, that’s a story that’s yet to play out. But what’s interesting is you did mention, you know, obviously, with inflation and rates going up, one thing that is another silver lining is cash in your savings account, which we know hasn’t been paying anything for years, is gonna start paying some pretty good rates.
• In fact, Treasuries, short-term Treasuries, six-month, one-year Treasuries are now paying 4%. Now, your bank accounts and your CD rates aren’t up there yet, ’cause they typically lag. But you know, that’s certainly something that we haven’t seen for quite some time and it makes attractive or makes it more attractive to invest at least in a very safe investment. At least you’re getting something for that.
• STEPHEN: We just showed on the screen the two-year Treasury that’s up to just over 4% at 4.2%. But that’s right, we are seeing these shorter-term rates finally increase. It’s been a long time coming. And the benefit of that is going to be over the next year of two, like you said, Chris, bank accounts, CDs, you know, some of these cash investment type products are going to offer higher yields. And guess what that also means. Equities, real estate, typically, those will also increase, in similar amounts, you know, based on inflation and based on interest rate assumptions and everything else.
• We don’t know how much more pain is ahead for the stock market and for real estate. Our crystal ball clearly can’t tell us. But it certainly seems like there’s a lot more positive news on the horizon instead of negative news. It was several months back that the Fed started hiking interest rates. It seems like they’re gonna slow that down or maybe eventually reduce rates over the next year or so. We’ve got still Russia and Ukraine lingering. That’s probably and hopefully closer to a resolution than not. And several other stories out there. I think, even China, right? We haven’t talked much about China recently, but they still have that very strict no-COVID policy, the COVID-Zero policy. Once that gets lifted, I think it’s gonna be very positive for the global economy.
• CHRIS: Yeah, and you know, we’ve said over and over, but it’s worth reiterating that, you know, the worst is typically over for stocks before it’s over for the rest of the economy. So prices lead fundamentals. Therefore, you know, the stock market falling into a decline is traditionally an indication that most investors are feeling like things aren’t gonna be great. And we finally fall into a recession, honestly, that’s usually when stocks start to do well.
• We’re in a situation where the market’s expecting the worst from the Fed. So any comments that suggest that they’ll be less aggressive will have a positive impact on the market. Same goes for inflation. We saw those numbers hopefully starting to come down, and you know, even though they’re gonna still be high, if they come in just a little bit better than expected, the markets can rally.
• At the end of the day, the stock market, it performs well or does poorly based on corporate earnings. And you know, it’s been pretty impressive to see how resilient a lot of, most of these, companies have been and a lot of it is because they had to go through some really great cost discipline during the pandemic to get through it. That being said, earnings estimates have come down and probably will come down a little bit more. From a valuation standpoint, stocks aren’t looking overly expensive.
• Finally, investor sentiment, which is very, very low right now, one of the lowest on record, that tends to be a very contrarian indicator. Which means it’s typically the best time to buy stocks are when everyone else is afraid. It’s the old Warren Buffett quote that I think we’ve said a few times on these videos, but it’s, “Be fearful when others are greedy and be greedy when others are fearful.”
• But as you mentioned Stephen, it’s impossible to predict these things and our recommendation is to stick with or revisit your plan, but don’t do anything drastic.
• STEPHEN: Exactly, so, even though the Fed did recently hike rates and we’re expecting that they’ll continue to do so, at least somewhat moderately through the rest of this year, it seems like there’s more positive news on the horizon than negative news to come. And maybe a lot of the pain is already behind us in terms of asset prices, like real estate, stock markets, capital markets, and everything else.
• But hey, if it’s been awhile since you’ve reviewed your financial plan, now would be a great time. Reach out to your advisor. Let’s set up a time to connect. And until next time, I’m Stephen Rischall, that’s Chris Carter, and this is “The Smart Money Show.”