As January goes, so goes the year. If that old market saying holds any weight, investors’ worry may be justified. The start of 2022 has certainly been rough.
Along with stock indexes falling between 5% to 10% in January, bonds have also added to the pain with a decline of around 2%. It’s safe to say that few investors have been spared from losses to start the year.
It’s commonplace to blame the Fed for all of this negativity. In their defense, the pandemic has presented a significant challenge. With their now-$9 trillion balance sheet, almost double its pre-Covid size, they have grown visibly uncomfortable in their unorthodox policies. They seem to be looking for the escape hatch from their homemade trap of zero interest rates. Increasingly, it’s not at all clear they actually built one.
Since their grand monetary experiment began in response to the Great Financial Crisis in 2008, the Fed did finally start to baby-step its way toward higher rates by early 2017. Covid suddenly arrived and the Fed pinned interest rates right back down to the floor. And, with that not seemingly enough to cushion the economy, they further juiced financial market sentiment by purchasing yet another $4 trillion of bonds. It worked.
Similar to a game of hot potato, their bond purchases sent investors seeking other, riskier assets; namely increasing demand for both stocks and real estate. This hot-potato effect may be the true magic behind their zero-rate monetary policy. It not-so-subtly shifts the mentality of the herd and sends them thundering off in riskier directions; pushing up the prices of riskier assets in hopes of feeding a sense of consumer and investor confidence.
What’s been happening since the start of 2022 is an example of the jittery herd deciding on its direction. With Covid’s final wave clearly cresting (we all hope) and with both unemployment way down and inflation way up, the Fed has telegraphed that a policy change is just ahead. They’ve penciled at least three 0.25% rate hikes throughout 2022, about a year earlier than expected. In addition, they’ve also sent the message that their business of buying bonds is soon coming to an end.
However, it’s important to note that the Fed’s shift is just one element of the current backdrop. Regardless of how it might seem, there are other factors to consider. We seem to be in the midst of a peculiar game of tug-of-war.
Holding on to the opposite side of the rope stands our post-Covid economy. The economy is quite strong and, in my opinion, it’s likely to both broaden and deepen its strength in the year ahead. As if churning just below the surface, there is a pending sense of a post-pandemic release of optimism and pent up activity. Even with elevated stock market valuations, the economy’s strength may not result in a match that ends with the financial markets facedown in the mud.
Keep in mind the irony of the current situation. If the Fed senses the economy’s footing is slipping, it’s likely to lighten up on its own effort. As it should be, the Fed’s true desired outcome is a healthy stalemate. Unlike most games of tug-of-war, a boring stalemate in this peculiar match is a win-win outcome. So far, the start of 2022 has been anything but boring! It’s likely to be an interesting year.
Jason P. Tank, CFA, CFP® is both the owner of Front Street Wealth Management, a purely fee-only advisory firm and the founder of the Money Series, a non-profit program committed to providing open-access to financial education, for all. Contact him at (231) 947-3775, by email at Jason@FrontStreet.com and at www.FrontStreet.com