Friday Thoughts
It appears that we skipped right through fall and into winter. We took the kids to Oconee State Park in Mountain Rest for Halloween weekend. We drove up in a light, warm rain for most of the trip on Friday afternoon as a front moved through. And, when we got up on Saturday morning, we were greeted to temperatures in the 40’s! It did warm up for our Saturday adventure to Chattooga Belle Farms, where we were hoping to do some apple picking. Unfortunately, a late frost wiped out the apple crop in the area this year, so we had to rely on picking muscadines and figs. We also stopped into the distillery on the property and got to see how they make their local fruits into brandies, rum, vodka, and whiskey. We finished the day with trick or treating at the park. All in all, it was great weekend.
A month ago, I wrote about the challenges that I saw facing the financial markets this fall and winter. I’ve written more about the political turmoil in Washington and the supply chain issues and the ensuing inflationary pressures. Some more clarity on those has come about it the last week or two that I’ll update you on at the end of this. I mostly want to focus today on the third issue - The Federal Reserve and their efforts to ease the accommodations they have been making since the COVID pandemic first hit.
A little background, first. The Federal Reserve is formally known as the “Federal Reserve System”, as it is a set of twelve regional banks that work together. It is often referred to simply as “The Fed”. They coordinate together to maintain a safe and secure banking system. The Fed is governed by a board of governors which are appointed by the President of the United States. There is also the Federal Open Market Committee (FOMC), which consists of the board of governors and the Presidents of all twelve of the Federal Reserve Banks (although only 5 of the 12 can vote, one of which is always the NY President and the other 4 rotate). The FOMC is the body responsible for setting the monetary policy of the entire body. When you read about “The Fed” meeting, it is usually referring to the FOMC.
Congress has tasked The Fed with maximizing employment and managing inflation as its two core responsibilities in managing monetary policy. It does this through its setting of short term rates that banks charge each other, setting the discount rate (the rates charged to banks that borrow from The Fed itself), and by openly buying and selling of US Treasury and federal agency securities. Historically, The Fed has let longer term interest rates be determined by the open market, except during times of unique challenges, such as the Great Recession.
When most people think or hear about the Federal Reserve (which I know you think about all of the time!), it's often regarding the federal funds rate. The Fed Funds rate is the target range The Fed has for short term rates that banks charge each other for loaning out their excess reserves to each other overnight. That’s the headline number. However, there is so much more to their actions, and that’s been even more the case since March of 2020.
When governments started shutting down economic activity in an effort to slow the spread of the COVID-19 virus in March of 2020, central banker knew they were going to have to step up efforts to keep the banking system, and the economy, from collapsing. They had already started lowering the Fed Funds rate for a few months as China and parts of Europe started to shut down. Then they slashed rates to zero (technically 0 - 0.25%). That got the headlines. They also started buying securities. They started buying $80 Billion of US treasury bonds and $40 billion of mortgage backed securities per month. The Fed Funds rate affects short term rates. The buying of $120 billion in bonds was an effort to keep longer term rates low.
By keeping interest rates low, they are hoping to keep people borrowing, and spending money. They have kept these accommodating measures in place since then.
With all of the Federal Government stimulus and spending flowing into the economy, coupled with low interest rates, Americans have been buying. It took a few months, but by May of 2020, it was getting hard to find a chest freezer, dishwasher, or many other durable goods item. By last fall, new car lots started to get bare. Sure, some of that is due to decrease in manufacturing because of shutdowns and supply chain issues, but a lot of it was demand. The increases in demand and limited supplies have lead to costs of these good going up - inflation.
I find it kind of ironic that as long as I’ve been in the financial industry, The Fed has been wanting to get inflation to 2%, and rarely could. Now, inflation has started to go above their target of 2%, and I’m not sure they have the ability to bring it back down.
Jerome Powell, The Federal Reserve chairman, has been very open about the fact that they think inflation will be short term and will come down on its own as the supply chain issues get worked out and we get back to whatever the next normal is. As I wrote two weeks ago, I don’t agree. The pandemic, and the governmental response to it, has had many people reevaluating what’s important to them and they aren’t as willing to do work that they find thankless and unfulfilling, regardless of pay.
As inflationary pressure has risen and seems to be longer lasting than they thought, the FOMC has finally begun to unwind some of their stimulative efforts. Just this week, they announced that they will slowly start purchasing less and less Treasury bonds and mortgage backed securities. This should cause longer term rates to go up.
What does this have to do with the stock market, though, you may be asking. I think that some of the excess money floating around in the system is getting invested in the stock market. I know that I have a number of clients who have quite a bit more cash than normal and they aren’t earning much on it at the bank or in money market accounts. Many companies have been borrowing at these low rates and using that money to buy back their own stock. If interest rates go up, some of that money invested in stocks may go back into more stable and “safe” investments like US Treasury Bonds or CD’s. Many companies may cut back on their own stock buybacks.
Of course, we have no way of knowing for sure how the markets will react. So far, they have been pretty accepting of The Feds actions. Many Wall Street analysts have actually been encouraging central bankers around the world, not just our Federal Reserve, to pare back their easing measures.
It’s just one more thing to watch and be aware of. I’ve found it fool hardy to try to predict short term moves in interest rates and stock markets. I am still a believer in investing in a well diversified, risk monitored portfolio. Being aware of the risks and opportunities are simply a way of preparing yourself for what you will see in the short term. But, always keep your eyes out longer term. In the longer term, we need rates to get back up to a normal level. Zero percent interest rates aren’t sustainable. So, we’ll get through this.
A quick couple of updates about some of what I wrote about a few weeks ago. After the elections this week, where Republicans surprised many with wins in Virginia and scares in New Jersey, the Democrats in Washington seem more determined to get some type of spending bill shoved through congress. They are under the impression that they lost because they couldn’t pass the spending bills. I think they lost because they’ve gone too far with their agenda and people don’t like what they’re hearing. I’m still not convinced that they will get anything passed. If they do, I think it’ll be a very stripped down bill (I can’t believe $1.5 Trillion can be considered stripped down, but that’s where we are in Washington) and will leave a lot of people disappointed on both sides.
As far as the supply chain issues, the story changes every day. Since I started writing this, a new report is out from Bloomberg. The number of ships waiting off the coast aren’t increasing at the same pace they were a few weeks ago, but they aren’t decreasing either. And, according to the report from Bloomberg, the ships waiting are larger and are carrying more containers.
The President announced an agreement to operate the Port of Los Angeles 24/7 a few weeks ago, but that’s an empty agreement. They don’t have room to unload the ships, as the ports are full of containers they can’t get moved. On the day that I last wrote, Jane Wells, from CNBC, wrote a great column about what she and Ryan Peterson (CEO of Flexport, a freight company) are actually seeing on the ground in Los Angeles and Long Beach. There aren’t enough truckers to move the containers.
And there’s another issue arising - too many empties. The empty containers are coming back, but the ports are full of full containers. They need a place to put them, out of the way. But, The City of Long Beach has a rule that empty containers can’t be stored more than two high. So the empties have to sit on a truck chassis while they wait. Each one having to hold an empty is one less chassis to haul away full containers. The following Sunday, Long Beach put a temporary halt to that rule, but we’ll see if it will make a difference.
And the issue still isn’t contained to the southern California ports. There are ships waiting off the shore of Savannah, Charleston, Baltimore, Norfolk, and New York, according to marinetraffic.com. This is an issue that’s going to take time to work through. I expect that it will lead to a longer term shift in mindset back to making things domestically, or maintaining a larger inventory state side for many manufacturers.
I am optimistic that over the long term, the United States will get through all of these issues. We remain a resilient people who figure out how to get things done. It just may look a little different than it used to. But, that’s ok. Today doesn’t look like 50 years ago did. We evolve, adapt and change. What’s the old saying? “The only constant is change”?
The holiday season is upon us and we have a lot to be thankful for this Thanksgiving. Clara and Sam Henry both had straight A’s on their report cards. Nancy Lee’s brother in law just got a promotion to Major General (that’s a two-star general for us non military folks). And my niece will be competing with her High School band for the SC State band championship over the next few weeks. I hope that you have a great weekend, stay warm, and take some time to count your blessings.