May you live in ‘interesting’ times 

In 1936, Sir Austen Chamberlain of England referred to a Chinese curse, “May you live in interesting times,” to describe the “the suffering of one disturbance and shock after another.” The pandemic has certainly tested our global economy and capital markets with a series of unique challenges and the pace continues as time passes in 2022.  

Our current “interesting disturbance” is the pervasive and all-encompassing adjustment to higher interest rates. The Federal Reserve is in the early stages of an aggressive tightening cycle to bring down stubbornly high inflation. Virtually all asset classes have been negatively impacted in some way, including bonds — which are traditionally the safest asset class. Across the risk-asset spectrum, the most speculative assets have been hit the hardest, while the least speculative have been treated somewhat better. Overall, there have not been many safe havens outside of cash. 

With the S&P 500 down close to 20% through June, history may not repeat itself, but it does rhyme. Throughout history, stock market reactions to regime changes tend to be quite similar. Declines are often reasonably short in duration, although reliably sharp and quite painful. More importantly, they can change investor psychology from “greed” to “fear.” This is where advisors like ourselves “earn” our fee. However, these events serve a very important purpose: excesses accumulated during the preceding period are rapidly cleansed from the system, and the foundation then begins to gradually build for the next cycle.   

In the early stages of the pandemic, and to avoid economic catastrophe, we experienced unprecedented monetary and fiscal stimulus. Much of what the Federal Reserve (the Fed) accomplished so quickly was the direct result of their yeoman’s work in the aftermath of the 2008 global financial crisis (GFC). As the pandemic took hold, the Fed dusted off their GFC playbook, and for the most part implemented the same game plan, but this time on steroids. The Fed’s COVID-era stimulus was about four times as large as the GFC and administered in only weeks instead of years. As a result, interest rates fell to zero … and stayed there. 

So too, was the size and speed of fiscal stimulus. Money poured from Washington into just about every quarter, like water from a firehose. Former Fed Chair Ben Bernanke once suggested that in the most extreme circumstances, the U.S. Treasury could, “drop money from helicopters” if necessary. Bernanke’s comment was quite prophetic in hindsight since in practice this is more or less what recently happened. The massive liquidity injection leaked into asset prices of every stripe. While most assets inflated in price, the byproduct was far from uniform. Investors’ speculative juices were stirred, and they poured cash into “investments” such as Bitcoin, Meme Stocks, SPACs, NFTs and other nontraditional speculative opportunities. We are now seeing a “great unwind” of these investments, highlighted by the Bitcoin chart below. 

Eikon 

Bond vigilantes 

The bond market didn’t wait for the Fed to finish its tightening cycle — it jumped in front. The chart below shows that while the fed funds rate is up 1.25% this year, longer-term rates have moved further.  

Bloomberg

This is being felt in the mortgage market meaningfully. The combination of sharply higher rates and rising values over the last few years is beginning to weigh on the housing market. A 30-year mortgage is currently just under 6%, this is up ~3% over the last six months. While 6% mortgages were very commonplace before the GFC, there is a generation of home buyers that hasn’t seen a mortgage rate over 5%. This rapid move in rates should slow the pace of home price growth. In the Boise housing market, over the last three years, the median home price is up 70%, from $360,000 to $620,000. This alone is making it difficult for first-time home buyers. However, with the increase in mortgage rates, from 3.7% to 5.9%, results in mortgage payment of just under $3,000, up from $1,400 in June 2019. This is a 110% increase. While incomes are up 25% over the last three years in Treasury Valley, this is nowhere enough for first-time home buyers.

Federal Reserve 

Soft landing? 

The Federal Reserve’s preferred measure of inflation, the personal consumption expenditure index (core PCE), rose 4.7% for the month of May, which was better than expected, following the worse-than-expected consumer price index earlier in June. What is telling in the data is that higher prices are affecting consumer spending; however, incomes continue to grow. Also, the labor market continues to remain tight with unemployment claims sitting at historic lows. If there is a recession, we believe it will be very shallow since, in broad strokes, the consumer is employed and making more money — perhaps giving us hope that 2022 will be, “less interesting.” 

— Jason Norris, a chartered financial analyst, is a principal with Ferguson Wellman Capital Management, which serves individual and institutional clients throughout the West.