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Key factors driving the current volatility

Here's a summary of what 's driving the current volatility in the market and what to expect going forward.

 

Higher interest rates fight inflation

For the first time in decades, the Federal Reserve is raising interest rates quickly to slow down economic growth and inflation. Higher interest rates make it more expensive to finance cars, houses, and business loans, thus reducing demand for these things, which is intended to stabilize supply and reduce prices.

 

Rising interest rates are great for savers

Savers are getting a good deal. Interest rate increases flow through to the institutional Certificate of Deposit (CD) market quickly. We buy millions of dollars at a time, so the institutional CDs we buy have rates that are usually better than local bank rates. You may have noticed more cash, Treasury Bills and CDs in your accounts recently until the latest known interest rate increase takes place next week. We build 'CD Ladders' in your account, with CDs maturing regularly on various dates throughout the year, so we can reinvest the proceeds at higher rates as they happen.

 

This next week the Federal Reserve is expected to increase interest rates by about 0.75%, and we expect to be able to lock in annual rates over 4% for the first time in 14 years. Expect to see significant activity in your accounts in the next week as we prepare to buy many more CDs.

 

Bond funds, however, lose money in a rising rate environment, so we exited traditional bond funds at the end of last year when the increasing rates were announced. In their place, you see short-term Treasury Bills in your accounts, because they hold their value until the interest rates go up enough for us to buy good CDs. 

 

Inflation is slow to reverse

When inflation is measured by the Consumer Price Index (CPI), housing plays an outsized role. There is a multi-month lag in seeing the full picture of housing price declines because lease and rent prices change only once a year. When inflation seems to make sudden big moves, it’s often because of rental housing prices, rather than all prices moving together.

 

Value stocks are expected to outperform

The stock market does not like rising interest rates, because it makes it harder for companies to borrow money to reinvest, more expensive for private equity firms to buy and sell companies, and consumers slow their spending. That said, some kinds of companies (value stocks) tend to weather the current rate environment better than others. 

 

Lots of activity for over a decade was based on borrowing money at cheap rates. The problem is that those very low rates are unsustainable, but markets have grown accustomed to them since they were introduced during the Great Recession in 2008. Tech stocks and other 'growth' stocks benefited from these low rates because they could borrow money to drive sales; profits would follow many years later, and investors were fine with that. Now, no one wants to wait many years for profits, so 'value' stocks do better in this environment. Value stocks are defined as companies that historically are quite profitable now and often pay dividends today.

  

What to expect from the financial markets moving forward

  • By most measures, inflation looks like it is at or close to a peak. Any rapid decline in CPI will have to be driven by Housing and Transportation, because those are the largest factors in the CPI. We are all watching new and used car prices, gas prices, and rent and housing data.

  • The Federal Reserve will raise rates again next week, but after that, inflation data will drive further action. No further interest rate increases are known, and the Fed may just pause to see the effect in the market so far. If inflation data indicates a decline, then further rate increases will likely be smaller and farther apart.