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Fed Plays it Cautious as Markets Wrap Up a Strong

| April 12, 2024

Fed Plays it Cautious as Markets Wrap Up a Strong

First Quarter It’s Spring, which means the first fiscal quarter of 2024 is in the bag. If Q1 is any indication of how the rest of the year will go, investors should be pleased. While 2022 marked a year of portfolio shrinkage due to skyrocketing interest rates, and 2023 was a year of strong recovery, signs so far are pointing to another good year. Of course, we still have three more quarters to get through, and anything can happen.

With that said, there’s nothing wrong with celebrating the positive developments we’ve seen in the markets these past few months. As you may know, Wall Street ended March with the Dow Jones Industrial Average and the S&P 500 both at record highs, and the Nasdaq also up on the year. The S&P had its best first quarter since 2019, and the Dow came close to hitting 40,000 for the first time ever.1  Although much of the market’s growth is still being driven by the AI tech boom, other sectors are doing well, too, thanks to a lot of strong economic data and the Federal Reserve’s continued cautious stance on interest rates.

As you know, the Fed basically caused all the market turmoil two years ago by raising short-term interest rates at a historically aggressive pace to fight inflation. They slowed that pace dramatically last year and ended rate hikes altogether before the end of 2023, as inflation fell to within one percentage point of their 2% target. Although inflation has remained sticky at around 3%, the Fed has declined to raise rates further at their last five policy meetings, including their most recent meeting in March.2

‘Fully Committed’

At that meeting, Chairman Jerome Powell said the Fed remains “fully committed” to bringing inflation down to 2%, but that that they don’t want to run the risk of causing a recession by raising rates again. At a range of 5.25-to-5.5%, short-term interest rates are already the highest they’ve been since 2007, and they remain slightly higher than long-term rates. That means despite strong GDP growth, low unemployment, and other good economic data, the nation’s yield curve is still inverted, which is concerning. An inverted yield curve puts financial pressure on banks and other lending institutions and has long been considered a recessionary warning sign.

Nevertheless, Chairman Powell’s message drew a positive reaction from investors, even though it included no clear indication of when the Fed might start lowering rates again. Some analysts were predicting we’d see numerous rate decreases this year. But with inflation still not fully reigned in, those predictions have changed. The Fed is still expected to lower rates at least once or twice this year, but now the first cut isn’t forecast to happen until June at the earliest.

That means the inverted yield curve will remain an issue, which is probably why long-term interest rates saw a slight spike in early April, in the wake of the Fed’s meeting. The interest rate on the 10- year government bond ended March at 4.20%, then jumped to 4.36% by April 2nd.3 That’s not unusual, though, since the 10-year has been vacillating between about 4% and 4.4% for most of the year. Relatively speaking, that represents a pretty stable bond market, and when you have that along with a rising stock market, investors should have little to complain about.

Looking ahead, probably the most concerning issue for the markets is the possibility of a resurgence of the regional bank scare that rattled investors last year. Five regional banks failed in 2023 and dozens more were deemed “at risk” by the FDIC. As mentioned, an inverted yield curve creates major challenges for banks – especially smaller ones – since banks generally need long-term interest rates to be higher than short-term rates in order to make money.

Although the Fed and FDIC took steps last year to address the problem and shore up regional banks, as long as the yield curve stays inverted, the issue remains a concern. The good news is that if problems do resurface and start spilling into other areas of the economy, the Fed is well-positioned to fight back by lowering interest rates. In fact, the bank issue is probably another major reason why they’re keeping short-term rates exactly where they are for now: they want to make sure they have plenty of ammunition if they should need it.

Your Portfolios

As noted earlier, if the first quarter of 2024 turns out to be a bellwether for the rest of the year, that’s good news. As you may recall, at the end of February our Sound Income Strategies portfolios of bonds and bond-like instruments were up by about 1% for the year on average. That meant we were right on pace, pro rata, for about 6% annual growth, which is roughly our target. As you’ll see in your latest statement, March brought us up to about 2.5% growth for the year on average (depending on your individual holdings). That means we’re now ahead of the game and on track for an average growth rate of around 10% by year’s end! But, as I also noted earlier, anything can happen.

Keep in mind that the additional 4% at this point is all speculative. We could easily give back most or all of March’s extra growth this month or at any time. As I explained in a previous newsletter, it’s important to remember that your monthly statement represents a snapshot in time, and that the picture can always change quickly.

What’s even more important to remember, of course, is that when you’re investing for income, any growth or shrinkage in your asset values on paper is largely irrelevant because your interest and dividend return are unaffected. Yes, seeing your values shrink can be distressing, and seeing them grow can be rewarding from a psychological standpoint. But at the end of the day, it’s all about the income, and that’s something you can count on no matter what!