The FED’s Inflation/Interest Rate Policy Plays A Major Role
Monday, May 20, 2024
For many years, I subscribed to the Zweig Forecast, an investment newsletter written by Martin Zweig. Zweig was a regular panelist on Wall Street with Louis Rukeyser. He famously predicted the market crash of October 19, 1987. One of Zweig’s well-known investing
aphorisms was, “Don’t fight the FED.” In other words, if the Federal Reserve is raising interest rates, be more defensive on stocks. If the Federal Reserve is cutting interest rates, be more aggressive on stocks.
An important consideration of Zweig’s “DON’T FIGHT THE FED” philosophy will unfold this Wednesday (May 15) at 10AM EDT when the US Bureau of Labor Statistics releases the Consumer Price Index (CPI) for April. The CPI is the most widely used measure of inflation. The experts are expecting the 12-month CPI to increase 3.4%. Of course, nothing in economics is simple. Keep in mind that the CPI is a complicated formula that seeks to measure inflation experienced by the typical American family. Since a major portion of the CPI is volatile food and energy prices, economists have tried to tamp down this volatility by excluding food and energy prices. They call the CPI excluding food and energy “Core CPI”, which is expected to register 3.6% on Wednesday. Over the longer timeframe, CPI and Core CPI tend to converge, but they can differ substantially in the short run. Since no one in Washington follows the KISS (Keep It Simple, Stupid) Principle, the Federal Reserve Board has recently let it be known that they prefer another measure of inflation known as the Personal Consumption Expenditures Price Index (PCE). The PCE, which comes from a different government bureaucracy, is considered a broader measure of inflation with less emphasis on housing costs, and it better measures consumer behavior, such as substituting hamburger for steak when prices are rising. As you might expect, the FED will also consider Core PCE by excluding food and energy prices.
Keep in mind that the CPI is a complicated formula that seeks to measure inflation experienced by the typical American family.
The unprecedented level of government spending combined with the FED’s super low interest rate policy following the Covid pandemic are thought to have caused the painful bout of inflation that hit the US economy in 2021. To quell this inflation, the FED responded by hiking interest rates from virtually zero to over 5%. This would have been a good time to remember: “DON’T FIGHT THE FED”. Stocks tanked in 2022. Now, in 2024, all eyes in the investment community are watching these inflation readings for signs that the FED may reverse course and begin reducing interest rates in order to support job creation in the US economy. Economic growth creates jobs and paychecks for American families. We think the strength in the stock market since last October may be largely attributable to the market’s perception that inflation is trending toward the FED’s target rate of 2%, and this lower inflation will permit the FED to reduce interest rates, which will spur economic growth. For example, lower mortgage rates will stimulate housing, and economic growth is rocket fuel for the stock market.
So, we’ll be watching the CPI numbers on Wednesday. If inflation is lower than expected, the stock market may rally as the FED’s tight money headwind may flip to a tailwind in the coming months. On the other hand, if inflation ticks up, “DON’T FIGHT THE FED” says to stay defensive. A few days later, CPI chatter will fade from the headlines, and the investment community will turn its attention to the PCE inflation numbers that will be released on May 31.
At Riverfront, we believe the FED’s inflation/interest rate policy plays a major role in the stock market. Making sound investment decisions requires keeping your head on a swivel. The “DON’T FIGHT THE FED” philosophy is one important aspect in a complex mosaic of factors affecting the investment environment. Also, this week we will see the Producer Price Index, the Index of Leading Economic Indicators, Industrial Production and Retail Sales. We strive to stay well informed and apply our experienced judgement in managing our clients’ portfolios. Our investment policy continues to reflect diversification and asset allocation with a tilt toward capital preservation.
Bruce Robinson, CFP
(The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.)
Comments