At its June meeting, the Federal Reserve confirmed what many of us have suspected for some time: prices are rising. In fact, prices are climbing faster than many expected. In response, the Fed raised its inflation expectation to 3.4%, up from its March projection of 2.4%, effectively raising its inflation expectation by 42%.1
The Fed’s course correction on inflation expectations and planned interest rate hikes unsettled the financial markets, with further volatility felt after St. Louis Fed President James Bullard said that the first interest rate hike could be as soon as 2022.2
The Fed also indicated that two interest rate hikes in 2023 were likely, despite signals last march that rates would remain unchanged until 2024.3
So, what’s an investor to do?
It’s important to remember that inflation is just one of the factors considered when creating a portfolio. If inflation trends higher than expected for some time, adjustments may need to occur.
Fed Chair Jerome Powell also said at the June meeting that he believes that inflation will be transitory. But as evidenced by the recent changes, the Fed remains ready to update its outlook as economic data continues to accumulate.
In a recently updated article by Investopedia, the nature of inflation in terms of being expected or being unexpected held the most conclusive findings in moving financial markets. It is of note, historically speaking, that when inflation is unexpected it can have negative impact of real-returns in the markets (real returns being inflation adjusted returns). This is because when inflation is unexpected it carries the weight of 'new information'. When the market digests new information in an unexpected way we experience price volatility! If you've been our client for long, you know these instances first hand: Brexit, the Fed's taper tantrum, Covid-19 pandemic, and even the 2008 housing market crash.
The simple fact that the entire world is already talking about and monitoring inflation should help the expected nature of it. The barometer we are watching is the 10-yr Treasury yield. Peaking around 1.75% in March of 2021 but back down to 1.48% in June, we are looking for a range bound trend. Breaking out of this range in a swift manor would resonate the 'unexpected' bell.
If you’re concerned about inflation, please reach out. As the economy continues to strengthen, economic trends and themes are evolving quickly. We’d welcome the chance to hear your thoughts.
1. The Wall Street Journal, June 16, 2021
2. StLouisFed.org, June 18, 2021
3. The Wall Street Journal, June 16, 2021
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