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Friday Thoughts

I’m typing this from home today, as we’re buckled down, waiting on Hurricane Ian to come ashore. One of my goals when establishing Axis Wealth Planning was to set everything up so that I could work from anywhere. It’s days like this that I’m thankful for that. Hopefully you’re safe and prepared. I’m hoping that we will get though this with minimal damage, but I do worry for my friends in the Grand Strand area. We’re supposed to be going to Ocean Lakes Family Campground next weekend with the camper for Halloweekend. Fingers crossed that they will be okay.  

I’ll try to keep today’s thoughts fairly brief. I had a client ask me a very good question after last weeks Friday Thoughts that I thought I would share today. The question was - If you were the Federal Reserve Chairman, what would you be doing right now to deal with inflation, rising rates, and the economic slowdown?

First - There is no way that I would ever make it close to being a Fed Chair. The Federal Reserve Board is comprised of people who have spent their careers in Academia, the Government (usually the Treasury or White House), and at the Federal Reserve itself. A few of them may have spent a couple of years on Wall Street. But, the Fed doesn’t tend to have members who have ever had to figure out how to make payroll on Friday, or how to meet a market need in a small town community. That’s one of my biggest criticisms of them - they’re removed from the every day reality of the average American.

That said, I think it’s a fun exercise to think about what I would do if I were in Jerome Powell’s seat. It’s not as fun as imagining what I would do if I won the Powerball (I would have to play it in order to win, so that won’t be happening), but for me, it’s still a fun exercise. I’ve spent much of this week thinking about it. 

The very first thing that I would do is publicly acknowledge that the Federal Reserve made a huge mistake by keeping interest rates so low for so long. This is yet another reason why I’ll never be a Fed Board member - I’m too honest. By keeping rates so low for so long, they have distorted the valuation of all types of financial assets, namely stocks. When interest rates are close to zero percent, why would anyone want to put their money in short term fixed rate investments like CDs and bonds? Instead, they bought stocks and drove up the value of them. 

With the massive debts that we’ve been running over the last few years, someone had to be buying all of those bonds that the US Treasury had to sell. If it wasn’t everyday average Joes, who was it? The Federal Reserve! The term they use is “growing their balance sheet”. For Main Street America, that means that they made up money - they printed whatever they needed. Surprise, surprise, with all of that money floating around, costs go up. That means inflation. 

The Fed seems to have finally realized their error. However, since they are now behind the eight ball, they are reacting with a heavy hand. My concern is that they could be over reacting. 

So, the next thing I would do as the Fed Chair is to slow down the interest rate increases. The Fed has raised the reserve rate by .75% for three meetings in a row. I think those increases were justified in order to get rates back to a “normal” range. But, it takes time for interest rate changes to impact economic activity. Businesses, and individuals to a lesser extent, plan they’re large scale spending projects well in advance. Many projects can take years and years to complete. Three or four months of interest rate changes won’t impact many of those long term plans for years. Now is time to take a pause and let the previous rate increases sink in.

Since it can take months and months for the increases in rates to affect economic activity, continuing to raise rates could very well lead to over doing it on slowing down the economy, just as keeping rates too low for too long lead to the economy over heating and having to deal with inflation. 

Rather than continuing to raise the Federal Reserve Rate, I would continue to allow their Treasury and mortgage bonds to mature without buying more. They call this “shrinking the balance sheet”. For us normal, everyday folks that means that they are no longer buying those bonds and keeping longer term interest rates artificially low. They need to allow the market place to find where rates should be when considering the risks associated with them, such as default, inflation, and term risks. The largest concern in this is that it will lead to higher rates on US Treasury Bonds. And, because the US treasury owes so darn much, it will cause the carrying costs of all of that debt to go up. Think of it as the minimum payment on a credit card bill. 

That issue leads to another thing that I would be doing as Fed Chair. I think someone needs to head over to Capital Hill and have a very frank conversation with Congress about our out of control spending. It seems to be a taboo thing to discuss, but we MUST reign in the spending. We are massively in debt. Debt is simply spending tomorrows income on today’s wants. When we are this far in debt, there is no more of tomorrows income. It’s already spent. 

All of that government spending is fueling inflation just as much as the low interest rates. I’d argue that it’s even more impactful than rates. An example is the so called “Inflation Reduction Act”. It spends $391 Billion on “energy security and climate change”. $9 billion of that is allocated toward tax credits for things such new heat pumps, high efficiency windows, home solar panels, water heaters, and air conditioning units. A friend of mine is in the HVAC business and he can’t get home air conditioning units now, before this new money gets thrown into the economy. Imagine what the cost of new units will do next year, when the new efficiency standards and this money kick in!

The Federal Reserve has a tough task ahead of them. Unfortunately, they have backed themselves into a tight corner over the last several years. As much as they want a “soft landing”, it’s becoming obvious that is not likely. Since no one is willing to even consider cutting federal spending, the Fed has to use the only tools they have to kill inflation. And by raising rates and lowering their balance sheet, they are putting the US economy into a recession. The only question left in my mind is how bad and how long of a recession it will be.   

Just like we prepared for Hurricane Ian by being sure we had several days of food, the generator was checked out, gassed up and run for a while, and we brought in anything not strapped down in the yard, I want to encourage you to prepare for an economic slow down. Especially - pay close attention to your monthly spending. Are there subscription services that you can cut, such as streaming services? Are there ways to be more efficient in your grocery and eating out bills? Are there things that you can delay spending money on for a year or two?

Recessions are a necessary part of the economic cycle. They are a way to weed out the struggling and inefficient businesses and industries. Once they are closed, the resources that had been used to keep them afloat get to be used in better and new endeavors. There is a normal birth, life, and death cycle to businesses. Most people in America know this. I think the folks in Washington have gotten the idea that they can change that somehow. They need to get back out into the real world of small town USA. 

That leads to the last thing I’d do as Fed Chair. I would make every board member move out into middle America. Not Atlanta or Seattle, but rather somewhere like Carrolton, GA or Olympia, WA. I’d have them go to the local Piggly Wiggly to buy groceries, not order from Hello Fresh. I’d have them have to pump their own gas a drive around town, rather than take a train or hail an Uber. I’d have them live as normal of a life and you and I. Maybe then they would actually see the impact of the decisions they make. Those impacts affect all of us every day. But, to many of the academics and government officials, it’s just numbers on paper or a computer screen. 

With that, I’m going to put a wrap on this and get it to compliance before we lose power. As I’m typing, the winds seem to be picking up a bit. I fully expect some trees to come down and power to come and go. Thankfully, it looks like we’re only expecting gusts to 50 mph or so, much better than what the folks in Florida had to deal with. I fully expect that over the next few days we’ll be seeing some horrifying scenes from there. There are simply too many houses too close to sea level in that part of the country not to have massive loss of homes and businesses. 

Please stay safe and call me if you have any concerns that you would like to discuss.

The views stated in this letter are not necessarily the opinion of First Allied Securities, Inc. and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein.  Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed.  Past performance does not guarantee future results.

“Cetera Financial Group” refers to the network of independent retail firms encompassing, among others, Cetera Advisors, Cetera Advisor Networks, Cetera Investment Services (marketed as Cetera Financial Institutions or Cetera Investors), Cetera Financial Specialists, and First Allied Securities. All firms are members FINRA/SIPC. Cetera Financial Group is located at 655 W. Broadway, 11th Floor, San Diego, CA  92101