The “I” words dominated the month of September - Inflation and Interest Rates. The average American who puts gas in his car and food on the table is well aware of inflation. It is here.
Leaders of the Federal Reserve and the U S Treasury have both been using the word transitory for months now in reference to inflation. Inflation is expected to be transitory. But, Fed Chairman Powell took a slightly different stance in comments during a panel discussion hosted by the European Central Bank on September 28th. He said he finds inflation pressures to be frustrating. He conceded that inflation pressures have lasted longer than expected and now he expects rising prices to continue into 2022. He hastened to say that he anticipates the inflation rate to return to the Fed’s desired norm of 2% by the end of next year as the supply chain improves, full employment resumes, and demand returns to pre-pandemic levels.
The Chairman said we could expect to see a decline in the bond purchasing program by the end of this year, and interest rates increasing by the end of 2022. However, he was quick to say that if necessary to tame inflation, rates would increase before that time.
The bond market is not waiting for the Federal Reserve to act. As a reminder, the Federal Reserve sets short term rates but long term rates are set by the bond market. On September 15th the yield on the 10 Year Treasury was 1.26%. By the 30th it had risen to 1.53%. That is a strong move in a two-week period. It appears bond investors are expecting higher prices, i.e. inflation, and so they are looking for a higher yield to offset the increase in prices.
After a more orderly August, the stock market resumed the volatility and choppy trading sessions we have experienced this year since February. Small and mid-cap stocks have been range bound since the February highs. They made a run in September to break above that high, and failed again. Large caps joined the choppy trading and closed down for the month of September losing most of their July and August gains.
Stocks which benefit the most from rising interest rates are financial stocks, especially banks. Stocks benefiting from rising inflation are energy stocks. Stocks negatively impacted by rising interest rates are technology and growth stocks. We saw that play out in stock prices at the end of September.
Range-bound, choppy markets are frustrating. You feel like you are taking one step forward and one step back and treading water. However, it is part of the investing process and history shows this type of year often follows a year of significant gains, so this trading pattern is not without precedence. Eventually the market will break one way or the other and move out of this range. It will either break to the upside and put in new highs or it will break down and put in lower prices.
There is still plenty of reason to be optimistic that the break will come to the upside. Patience and discipline usually pay off. It is important to watch what the market is doing and not make moves based on what you expect the market will do.
Written by Connie C. Guelich, CFP, AEP, CLU, ChFC. This represents our views at the time of this writing, and it is subject to change. It is not intended to be personal investment advice. If you would like to discuss your own account, please don’t hesitate to call us.