As expected, the Federal Reserve raised its policy rate to 5.25-5.5% at the July FOMC meeting. What caught markets off guard was the cautious tone from Fed Chairman Powell.” Despite recognizing that a softer core CPI reading for June was just one data point, Powell suggested it significantly affected the Fed’s assessment of inflation risks. Although he didn’t rule out additional future rate hikes, he insisted that the economy needs to experience the full impact of the current policy before making further changes. Powell stated that the Fed had “covered a lot of ground and the full effects of our tightening have yet to be felt”. He added that the Fed would closely monitor the incoming data before the September FOMC meeting and noted, “we hope that inflation will follow a lower path as will be consistent with the [June] CPI reading”. Powell’s comments signaled that the Fed might be near the end of its tightening cycle.
Is Monetary Policy Now Restrictive? Powell’s comments indicated that the Fed believes that current monetary policy is now restrictive, meaning they have raised rates to a level that could put downward pressure on economic activity and reduce inflation. But is there evidence to back this claim?
Core PCE, short for Core Personal Consumption Expenditures, is a significant indicator of inflation used by the Federal Reserve. It measures the average changes in prices paid by consumers for a basket of goods and services, but unlike other inflation measures, it excludes food and energy prices. The Fed often focuses on Core PCE because it provides a more stable view of inflation and can guide decisions on interest rates and other monetary policies. Core PCE services excluding housing, which accounts for more than half of the PCE basket currently shows no moderation in inflation. Neither does its underlying driver, which is solid consumption and wage growth.
The observed moderation in inflation is primarily a reflection of the unwinding of pandemic-driven distortions in the pricing of goods and rents. Economic activity has also continued to remain resilient with real GDP growing at a sound annualized pace of 2.4% in Q2, and the economy continuing to record solid monthly payroll gains. These are indications that current financial conditions are not yet restrictive.
The effect of interest rates on home prices is another area of debate. Despite rising interest rates, home prices have gone up, and rents in some cities are rising too. This could add to inflation pressures, making it even harder for the Fed to guide inflation back to target levels.
The market is currently expecting rate cuts next year, but this might be challenged by inflation trends. If inflation doesn’t slow down as much as the Fed expects, they might not be able to cut rates next year. This could lead to surprises in the bond market and require further adjustments to the policy rate. We still believe that the Fed will have to hike rates further to get inflation down to their 2% stated target.
“GOLDILOCKS SCENARIO” WON’T LAST
A “Goldilocks” view has settled in global financial markets, where expectations align with just enough economic growth to bolster corporate earnings, alongside hopes for inflation to decelerate enough to allow rates to be cut. However, we believe this outlook may be short-lived.
The Fed, like other developed market (DM) central banks, is data-dependent, awaiting stronger indicators or evidence of persistently high inflation to trigger additional rate hikes. The Fed has continued to believe that they are able to orchestrate a “soft landing” for the markets that will allow inflation to dissipate without causing a significant rise in unemployment or a recession.
The latest macro data is sending a clear message that interest rates and/or bond yields are not yet restrictive and will ultimately need to move higher before the economic expansion becomes threatened. If bond yields do move higher (which we expect), stocks may come under pressure. Expensive areas of the market will be especially at risk of a re-rating.
This is especially true for the leading U.S. economy and prolonging the economic expansion will put a floor under inflation. The U.S. consumer survey by the Conference Board presented an unexpected shift in July, pointing to resilient consumption, and strong indications that service sector inflation will continue. The greater the delay in restrictive monetary conditions, the higher the chances of inflation becoming entrenched.
Also, despite higher mortgage rates affecting new home buyers, most existing homeowners are shielded, having locked in low borrowing rates. The phenomenon of “excess savings,” a result of the pandemic, continues to be spent, further bolstering consumption through at least 2024.
The Fed has persistently underestimated the required level of policy rates needed to generate economic slack. A decisive breakout in G7 government bond yields is a clear threat to the rally in risk assets. Macro factors, rather than the Fitch downgrade of U.S. government debt, will be the driver of higher U.S. Treasury yields.
“REVENUE SHARING” – CONFLICTS OF INTEREST BETWEEN MUTUAL FUNDS AND ADVISORS
As a result of the shifting regulatory environment in the financial industry, I wanted to shed some light on an issue that may be undermining your financial future or that of your friends, family or colleagues. Revenue sharing programs between mutual fund companies and wealth management firms raise some serious questions about conflicts of interest.
In a recent article titled “The Big Bucks Mutual Funds Firms Kick Back to Wealth Managers,” posted on www.financial-planning.com, the extensive revenue-sharing agreements between mutual fund companies and wealth management firms like Ameriprise, LPL Financial, UBS, Morgan Stanley, Edward Jones, and others were brought to light. This revenue sharing often comes in the form of “marketing” or “partner” fees, potentially amounting to hundreds of millions of dollars depending on the company. Many of these arrangements include firms receiving larger compensation for recommending more expensive products. This misaligned incentive can lead wealth managers to prioritize their own profits over their clients’ best interests.
These revenue-sharing arrangements are often murky, intentionally confusing or hidden from clients. Micah Hauptman, the director of investor protection at the nonprofit Consumer Federation of America, refers to these arrangements as “opaque” and highlights that they can influence financial professionals to recommend products that may not necessarily align with the clients’ best interests.
Most advisors, banks and insurance companies do not provide a detailed listing of their participating in their revenue-sharing programs. This lack of transparency further clouds the decision-making process for investors.
Pacific Coast Investment Advisors: The Unbiased Advocate –
At Pacific Coast Investment Advisors, we believe that financial advice should be clear, transparent, and free from hidden incentives. We do not receive any form of compensation for any recommendation that we provide. Our advice is not influenced by third-party payments, and our commitment is solely to you, our valued clients.
The big bucks that mutual fund firms kick back to wealth managers represent a substantial conflict of interest that can hamper the integrity of financial advice. While regulators like the SEC have taken steps to address these conflicts, more transparency and ethical practice are still needed.
At Pacific Coast Investment Advisors, we want you to know that we stand apart from these industry practices. Our commitment is to provide unbiased, transparent financial guidance that truly serves your needs. When you entrust your financial future to us, you can be assured that our recommendations are made with your best interests.
For those interested in understanding more about our practice and the values that guide us, please feel free to contact us.
CASH MANAGEMENT – WHAT IS YOUR INTEREST RATE AT THE BANK?
As of this writing, US Treasury bills with a 6-month maturity currently yield 5.5% and are exempt from state income taxes.” US Treasury bills are backed by the full faith and credit of the US government and offer a much safer return than most bank or credit unions can offer. US Treasury bills are considered cash equivalents, and are extremely liquid. If you have savings money that you want a safe attractive return on, contact us for further information.