Our Federal Reserve raised the interest rate on the overnight rate that banks charge each other (Fed funds rate) by another .75%. The Fed has kept that rate near 0% for most of the last 10 years to support the economy after the 2008 banking crisis. Inflation remained below their 2% target rate. Now the rate is near 4%.
When Covid and the lockdowns hit, our government issued Treasury bonds, borrowing amounts necessary to support the economy. The Fed then bought those bonds with newly created cash. The money supply increased while the supply of goods and services was constrained. Inflation, which is the adjustment force that balances the amount of good and services (supply) with the amount of money in circulation (demand), kicked in. Inflation rose to 8% or more by many measures. Hence, the Federal Reserve was forced to raise rates to stop inflation from becoming embedded in the economy.
“Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.“
In turn, the 10-year Treasury bond (the rate that matters to you and me) has increased dramatically from 1.7% to 4% this year. Many of the interest sensitive, long-term, investment grade bond funds declined up to 30%. Of course, the stock market also got hit.
As I discussed in April, the Covid lockdowns are behind us, government overspending is no longer necessary, and hopefully, the war in eastern Europe will somehow be resolved. The supply of goods and services (and U.S. oil production) is increasing. Balance is being restored.
Of note, the long-term rates have not risen as fast with the Fed’s short-term rate increases (a negative yield curve). This implies that the demand for goods and services is subsiding. With economic output recovering, inflation (and interest rates) will normalize, and the economic shock caused by the Covid nightmare can be put behind us.
We at WST suggest you look out past the current turbulence and towards the future. You may see opportunity.