Fed’s ‘2 minute warning’ | Nasdaq

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By Kevin Nicholson, CFA, Global Fixed Income Co-CIO, co-head of the investment committee

SUMMARY

  • We believe Jackson Hole can serve as a two-minute warning to the Fed to announce its reduction in quantitative easing (QE) buying.
  • The United States has a problem of supply, not demand, and just needs time to balance itself out, in our opinion.
  • We expect the 10-year Treasury to end the year in the 1.50% -1.75% range and equity markets to continue moving higher.

What the reduction in assets means for the markets

The Jackson Hole Economic Symposium begins August 26, and this three-day event could be one of the biggest political events of the year. The Federal Reserve (Fed) will work out its plan to fulfill its dual mandate of maximizing employment and providing stable prices by keeping inflation around 2% over time. Since the start of the pandemic, the Fed has been the economy’s safety net. Their creation of emergency facilities during the early days of the pandemic helped prevent the economy from repeating the great financial crisis of 2008. To that end, they have added more than $ 4 trillion to their balance sheets since the March 4, 2020, buying bonds and thus keeping long-term interest rates low. The Fed’s balance sheet recently hit an all-time high, totaling $ 8.2 trillion (see chart below). However, with unemployment approaching 5% and inflation close to 3.5% as measured by Core PCE, Jackson Hole may serve as a “two-minute warning” to the Fed to announce that it is slowing down, or “slowing down”. is shrinking “as the Fed calls it, the size of its bond buying program – known as quantitative easing (QE). It is important to note that the reduction in asset purchases continues to support bond prices and add to overall liquidity.

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Past performance is no guarantee of future results. Shown for reference only. Not indicative of the performance of the RiverFront portfolio.

Review of the Fed’s dual mandate

Use:

The recent strength in the labor market makes it harder to argue that the Fed is not on track to fulfill its employment mandate. Monthly non-farm payroll additions have averaged nearly 617,000 per month so far this year, with an average of 940,500 in June and July. Momentum is building and as extended unemployment benefits expire on September 6, more workers are expected to enter the workforce. We believe this will help alleviate the labor shortage.

Shown for reference only. Not indicative of the performance of the RiverFront portfolio.

Inflation:

The Fed has predicted that inflation will be transient until the supply chain is fully online again. Currently, the core PCE is at 3.5% and headline inflation as measured by the CPI is at 5.4%. Since the Fed has not hit its target for so long, it has declared itself ready to let inflation soar for short periods of time. At RiverFront, we recognize that different parts of the economy will experience periodic episodes of inflation over the next 6-9 months. However, we share the Fed’s view that the current inflation rate will decline once the temporary supply disruptions related to COVID are mitigated.

Fed Outlook: Moment of taper

The actions the Fed took at the start of the pandemic were aimed at supporting a stalled economy. Thanks to quantitative easing, the Fed lowered interest rates, supporting both bank lending and consumer demand. By combining monetary stimulus with fiscal stimulus in the form of transfer payments (stimulus checks), policymakers have helped create a historic rebound in the US economy. It is for this reason that the United States has a supply problem and not a demand problem. We believe that a slowdown in QE would help rebalance the dynamics of supply and demand.

The Fed has repeatedly said it will give markets plenty of time before cutting back on QE purchases. Following the Jackson Hole forecast, we believe the Fed will officially announce its reduction plans at the September FOMC meeting and begin the reduction in November. The two-month grace period would honor the Fed’s intention to give markets sufficient notice before the cut, in our view.

What does tapering mean for the markets?

Once the tapering begins, we expect bond yields to rise. For context, we believe the ten-year Treasury yield (1.26% last Friday) will end the year in the 1.50% -1.75% range, returning to the higher levels seen in March of this year. year. Given that rate hikes are not expected until late 2022 / early 2023, continued earnings improvement should allow equity markets to rise. We believe that phasing out will allow time for the supply of goods and labor to catch up with demand, which will ease inflation concerns. If 10-year Treasury yields remain below 2%, we believe the equity market will benefit from a “gold loop” environment with growth “high enough” to generate profits, but “not so much”. high ”to cause interest rates to rise significantly. As a result, we continue to position our asset allocation portfolios to favor equities over bonds.


Important Disclosure Information

The above comments generally refer to the financial markets and not to the RiverFront portfolios or any related performance. The opinions expressed are current as of the date indicated and are subject to change. Past performance is no guarantee of future results and diversification does not guarantee profit or protect against loss. All investments involve some level of risk, including loss of capital. An investment cannot be made directly in an index.

Chartered Financial Analyst is a professional designation given by the CFA Institute (formerly AIMR) that measures the competence and integrity of financial analysts. Applicants must pass three levels of exams covering areas such as accounting, economics, ethics, money management, and security analysis. Four years of investment / financial career experience is required before qualifying for the CFA designation. Those enrolled in the program must have a bachelor’s degree.

Information or data presented or used in this document has been received from sources believed to be reliable, but its accuracy is not guaranteed.

This report does not provide recipients with sufficient information or advice on which to base an investment decision. This report does not take into account the specific investment objectives, financial situation or needs of any particular client and may not be suitable for all types of investors. Recipients should consider the content of this report as a single factor in making an investment decision. Fundamental and other additional analysis would be required to make an investment decision regarding any individual security identified in this report.

In a rising interest rate environment, the value of fixed income securities generally decreases.

When it comes to being “overweight” or “underweight” to a market or asset class, RiverFront refers to the weights of our current portfolios against composite benchmarks for each portfolio. . The discussion of asset class weighting refers to our Advantage portfolios. For more information on our other portfolios, please visit www.riverfrontig.com or contact your financial advisor.

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To review other risks and more information about RiverFront, please visit the website at www.riverfrontig.com and Form ADV, Part 2A. Copyright © 2021 RiverFront Investment Group. All rights reserved. ID 1798873

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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