economics – The Agnostic Investor

Markets in Review

2022 was the worst year of performance in 97 years for the bond market, ending the year -13.07% as measured by the Bloomberg U.S. Aggregate Float Adjusted Index. Equity markets did not fair much better with the most comprehensive view of the U.S. equity market, the Wilshire 5000 -19.00%.

The Federal Open Market Committee increased the federal funds rate from around zero to 4.25% to 4.50% in an attempt to reign in inflation. With an additional two increases this year the overnight rate now sits at 4.75% to 5.00%. Changes in the fed funds rate triggers a chain of events that effect short and long term rates as well as many other variables throughout the economy.

The Feds hawkish stance impacted the 10-year treasury or risk free rate as it more than doubled, ending 2022 at 3.88% after starting the year at 1.63%. The 10-year was 3.42% at todays close. Interest rates and bond prices have an inverse relationship meaning increases in interest rates cause the value of bonds to decrease, while rate decreases cause bond values to increase.

30-year mortgage rates hit historic lows diving to 2.66% in 2020, fueling the real estate market by decreasing borrowing costs and boosting home values. At the close of 2022 rates were 6.42%, up from 3.22% at the years start.

Some define recession as two consecutive quarters of negative Gross Domestic Product (GDP) growth. According to U.S. Bureau of Economic Analysis data the first half of both 2020 and 2022 were recessionary by that definition, though we continue to see slow growth over the longer term.

“The National Bureau of Economic Research (NBER) Business Cycle Dating Committee—the official recession scorekeeper—defines a recession as a significant decline in economic activity that is spread across the economy and that lasts more than a few months.”

When short term Treasury rates exceed long term rates the result is an inverted yield curve which is often used by economists and portfolio managers alike as an indicator a recession is to come. Federal Reserve Board of Governors Chair Jerome Powell has directed investors to focus on short term rate spreads to measure recession risk. The 3-month bill and 2-year note inversion may hold a strong correlation to recessionary periods.

Recent bank failures of Signature, Silicon Valley and Credit Suisse and fear of contagion may force the Fed to slow rate increases in the near term. In a 2021 article published in the Financial Times Federal Reserve Bank of Minneapolis President and CEO Neel Kashkari expressed the need for “banks to increase their equity funding to protect against the next shock.” It should be noted he made no suggestion of a return to the gold standard.

The 2020 policy shift to fractional reserve banking and the Fed considering the launch of a central bank digital currency make any prediction of what the future holds for our banking system and economy as good as my own.

Will unemployment rates stay at their current levels?

Will wage growth continue its upward trend?

Can the Fed tame inflation and avoid pushing the U.S. economy into a recession?

Financial Repression

In their 2011 paper Former Senior Vice President and World Bank Group Chief Economist Carmen Reinhart, and International Monetary Fund Economist Maria Belen Sbrancia brilliantly explain the “pillars” or economic conditions of financial repression and demonstrate how it is effective in the liquidation of government debt.

A term introduced in the 1970’s, financial repression is marked by ceilings on interest rates of government debt and the creation and maintenance of a captive domestic audience, meaning domestic financial institutions, business entities and households are regulated and motivated to purchase and hold government debt. Along with a steady dose of inflation these conditions amount to an invisible tax of negative interest rates, or a transfer from savers to borrowers. (Reinhart & Sbrancia, 2011)

The Federal Reserve System is the central bank of the United States responsible for conducting monetary policy under a dual mandate given to it by congress “so as to promote effectively the goals of maximum employment, stable prices and moderate long term interest rates.” The Federal Reserve controls three tools of monetary policy—open market operations, the discount rate, and reserve requirements. (Federalreserve.gov)

See Fed Functions: Conducting Monetary Policy

Federeal Reserve Recent Balance Sheet Trends

The balance sheet of the Federal Reserve has reached nearly $9T dollars, with increased purchases or easing occurring in the wake of the ’07-08 financial crisis, and again as a response to the slowdown caused by the COVID-19 pandemic and skyrocketing unemployment.

The Federal Open Market Committee (FOMC) has ended purchases and the reinvestment of maturing securities, what they define as balance sheet “runoff,” having also begun to increase the federal funds rate in increasing increments to 1.50 to 1.75 percent in June after starting 2022 at .00 to .25 percent.

The 10-year U.S. Treasury yield, generally referenced as a risk free rate, sat at 2.98% at the end of June, while CPI reached 8.6% annually in May according to Bureau of Labor Statistics release, and Personal Consumption Expenditures (PCE), the prefered measurement of inflation used by the Fed, reached 6.8% on an annual basis.

Review our Inflation Primer

According to the World Bank’s recently released Global Economic Prospect’s report Russia’s invasion of Ukraine has compounded the damage of the COVID-19 pandemic creating increased risk of a period of stagflation, or slow growth accompanied by elevated inflation.

“The current juncture resembles the 1970s in three key aspects: persistent supply-side disturbances fueling inflation, preceded by a protracted period of highly accommodative monetary policy in major advanced economies, prospects for weakening growth, and vulnerabilities that emerging market and developing economies face with respect to the monetary policy tightening that will be needed to rein in inflation.”

Should we expect interest rates to continue to rise, and if so for how long?

What does a recession mean to your household finances, income security and prospects?

How will increasing rates effect your goals of purchasing a new home or car, renovating your current home, relocating, taking a vacation etc.?

Would increasing the amount of your cash savings/emergency fund decrease your anxiety?

How might one lower their expenses in an inflationary environment?

Capital, Access & Influence

Exploring and gaining experience in the many areas of business and finance continues to inspire my appetite for change. Since childhood I have pursued meritocratic environments. My athletic career has disappointed deeply in that area. Though I continue to find marginal success in different areas, the returns have not matched the investment or risk taken.

Part of my pursuit for an environment that rewards individuals based on merit or metrics, has been the want to live without regrets or attachments; freedom. Many athletes and entrepreneurs have heard the “after all I have done for you” speech, considered requests for mentions or credit, heard rumors of others taking credit, or been offered an award or recognition as a means of association. Some of us have been ostracized for an unwillingness to do as we were told, or accept less than we believe we are worth.

To all associated parties, I say good day. It seems the primary tool of manipulation of consultants is to increase their perceived value by decreasing your self worth. My most recent search for capital has exposed a deceptive environment where profits seems to be the only priority, once you have decoded the obfuscation games.

Some may attribute it to capitalism then assert one of several cliches like “50% of something is better than 100% of nothing” or “venture capital is tough.” Herein lies our societal dilemma; is capitalism evil? Though I will not portend a solution, I can say with certainty capitalistic greed rears its ugly head in every socioeconomic system.

Consider gentrification, political corruption, wealth and income inequality, upward mobility, industrial equity; representative business ownership limited by access to capital are not issues exclusive to America.

The expectation may be that as a young black male, I see white male baby boomers closing doors in my face, but that has not been true in my experience. It is black men, an ethnically diverse group of women, some white men and diverse groups and organizations; some who hold the keys while others see opportunity but effectively slow progress.

The conversation changes… they assert your lack of experience, mention your arrogant confidence, leverage your lack of capital, demean and degrade wherever possible, publicly support equal opportunity and privately pursue opportunities that benefit them directly.

The best advice I can offer entrepreneurs is to identify then ignore the noise, know your worth and find your bliss. Though all of your goals may not be achievable if you set your sights high, with perseverance your impact may be felt for generations. For those who have an active interest in repairing society; in God we trust.