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Fed Pivots

The Fed Pivots

The Fed Pivots. The US Federal Reserve changed the saving, lending, and investing landscape for 2022. The Fed pivoted on its view of inflation, and no longer is the word “transitory” found in its statement. The changes to the Fed’s policymaking meeting statement are outlined in a recent article. The fundamental differences are that with inflation continuing to rise and unemployment declining rapidly, the Fed will reduce bond-buying quicker and potentially raise interest rates three times in 2022. This change is a major policy shift that has implications for savers, borrowers, and investors. In addition, the moves should tamp down inflation.

Fed Pivots
The Fed Pivots

Inflation is Surging

The Fed has a target for 2% core inflation. In its latest statement, the Fed acknowledged inflation had exceeded the target for some time. Core inflation as measured by the Consumer Price Index (CPI) was 4.9% through November 2021, excluding volatile energy and food prices. Inflation was even higher at 6.8%, including those two categories. However, there are signs inflation is slowing as energy, lumber, and other commodity prices have eased the past several weeks.

The Fed’s preferred gauge of inflation, the Personal Consumption Expenditures (PCE) Price Index, was at 5.0% in October 2021 and is expected to be 5.3% by year-end. However, the US Fed projects that inflation will be substantially lower at 2.6% next year, 2.3% in 2023, and 2.1% in 2024.

The primary reason inflation is surging is demand is outstripping supply for many items. A key driver is that labor is in short supply. The unemployment rate is again approaching the historical lows seen before the pandemic. The Federal Reserve projects that unemployment will be as low as 3.5% in 2022 and stay there until 2024. These numbers suggest that full employment has been achieved, one of the dual mandates for the Federal Reserve.

Source: Trading Economics

Many older workers left the workforce and realized they could make do taking early retirement. As a result, the workforce participation dropped from 63.4% to 60.2% and only recovered to around 62%. This percentage still leaves 1.6 million people out of the workforce.

Another key driver of inflation is tariffs imposed by the prior administration and mostly maintained by the current administration resulting in higher import prices. Yet another cause of inflation is delays and bottlenecks at ports, warehouses, trucking, and rail lines causing slow deliveries at higher costs. Supply chain challenges are usually addressed by sourcing materials, supplies, and other inputs from other countries. However, the global pandemic is affecting the global supply chain limiting flexibility resulting in price increases.

The Fed Pivots Quickly

Tapering Doubles

The Fed started tapering in November 2021. Before this month, the Fed was buying $120 billion in bonds per month. This amount was lowered by $15 billion in November and another $15 billion in December. The target end date for quantitative easing (QE) was June 2022. However, the Fed announced on December 15th it would reduce bond-buying by another $30 billion in January 2022, resulting in purchases of only $60 billion per month. This value is half of the dollar amount in October 2021. Hence, the Fed’s pivot means they will be on track to end QE by March 2022.

The goal of QE is to lower interest rates and promote borrowing and spending by consumers and businesses. For example, research has shown that QE during the sub-prime mortgage crisis lowered US Treasury yields, corporate bond yields, and mortgage rates resulting in more mortgage refinancing and bank lending. The bottom line was that borrowing costs were lower for consumers and businesses. In addition, this activity caused employment growth and a rise in the Gross Domestic Product (GDP).

Source: New York Fed

Hence, the logical conclusion is that a reversal of QE during the COVID-19 pandemic should increase yields and mortgage rates, acting as a brake on the economy. However, tapering is largely hypothetical since the last time it was implemented, the US experienced a taper tantrum.

Rate Increases May Happen

The Fed’s pivot means that rate increases may happen. At the December 15th press conference, the Federal Reserve signaled three rate increases in 2022. The current Federal Fund’s rate is between 0% and 0.25%, a very low level. The Federal Open Market Committee’s (FOMC) dot plot has three increases in 2022, three more hikes in 2023, and two in 2024 based on median projections.

Implications for Savers, Borrowers, and Investors

A pivot in the Fed policy has implications for savers, borrowers, and investors. Savers should see higher interest rates making cash more desirable. However, real rates are still negative after considering inflation. 


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Borrowers should see higher interest rates, especially in variable-rate loans. This point means auto loans, credit cards, and adjustable-rate mortgages (ARMs) will be more expensive for consumers. It also means refinance rates may rise.

Rising rates will theoretically make borrowing for businesses more expensive as corporate bond yields rise. This change may impact the ability of some companies to use debt to return cash to the shareholders. The bottom line is that companies with high levels of short-term or variable-rate debt will see higher interest costs and less cash flow for share buybacks and dividends.

Investors will be impacted as bond yields rise and prices come down. Long-duration bonds are more impacted than short-duration bonds. Riskier high-yield bonds tend to see sharp price declines because newer issued bonds have higher yields than older issued bonds.

Rising bond yields theoretically make higher-yielding stocks less attractive. Although, yields for utilities, real estate investment trust (REITs), and consumer staples stocks are still higher than bond yields in many cases. For example, the 10-year US Treasury yields only 0.93% lower than the S&P 500’s average yield of ~1.28%. However, banks may benefit from higher rates as the net interest margin spread between loans and deposits widen, making them more profitable.

Furthermore, tapering should lead to more stock market volatility. This event happened last time tapering was conducted and seems to be happening now, as demonstrated by the increasing volatility of tech and other growth stocks.

Final Thoughts on the Fed Pivots

Inflation started to show up early this year as the price of many basic necessities started to rise. However, Jerome Powell did not view it as sustainable at that time and forecast no rate hikes until 2024. This view point about inflation changed mid-year when the Federal Reserve indicated that there may be rate hikes in 2023. Now, the Fed is pivoting, which will have long-term implications for savers, borrowers, and investors. Interest rates will probably rise due to tapering. This rise will impact car loans, mortgages, and credit cards interest rates. Bonds will be impacted, as will stocks. Savers, borrowers, and investors should understand the implications and review their debts and investments.


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Chart or Table of the Week

Today I highlight Medtronic (MDT). The stock price is down further and below its pre-pandemic high. The company is experiencing headwinds from three sources: the Omicron variant of the COVID-19 virus, an FDA warning letter about quality issues at its Diabetes Business headquarters, and the experimental renal denervation system. Medtronic’s stock price is trading near its 52-week low and is down nearly (-20%) from the peak in early September and below the 50-day and 200-day EMA. The price-to-earnings (P/E) ratio has been below the average for the past decade, and the yield is the highest since the bear market during the pandemic. Medtronic is a Dividend Aristocrat with an excellent dividend growth rate of mid-to-high single digits. Investors may want to look at this stock now. The screenshot below is from Stock Rover*.

Source: Stock Rover*

Dividend Increases and Reinstatements

I have created a searchable list of dividend increases and reinstatements. I update this list weekly. In addition, you can search for your stocks by company name, ticker, and date.

Dividend Cuts and Suspensions List

I updated my dividend cuts and suspensions list at the end of November 2021. The number of companies on the list has risen to 541. Thus, we are well over 10% of companies that pay dividends, having cut or suspended them since the start of the COVID-19 pandemic.

There were three new companies added to the list this past month. The three companies were Hoegh LNG Partners LP (HMLP), Sturm, Ruger & Company (RGR), and Compass Minerals (CMP).

Market Indices

Dow Jones Industrial Averages (DJIA): 35,365 (-1.68%)

NASDAQ: 15,170 (-2.95%)

S&P 500: 4,620 (-1.93%)

Market Valuation

The S&P 500 is trading at a price-to-earnings ratio of 29.1X, and the Schiller P/E Ratio is about 38.8X. These two metrics were down the past three weeks. Note that the long-term means of these two ratios are 15.9X and 16.8X, respectively. 

I continue to believe that the market is overvalued at this point. I view anything over 30X as overvalued based on historical data. The S&P 500’s valuation came down as the index companies reported solid earnings for the second consecutive quarter.

S&P 500 PE Ratio History

Source: multpl.com

Shiller PE Ratio History

Source: multpl.com

Stock Market Volatility – CBOE VIX

The CBOE VIX measuring volatility was down ~nine points this past week to 30.67. The long-term average is approximately 19 to 20. The CBOE VIX measures the stock market’s expectation of volatility based on S&P 500 index options. It is commonly referred to as the fear index.

Source: Google

Fear & Greed Index

I also track the Fear & Greed Index. The Index is now in Fear at a value of 26. The Index is down 12 points this past week. This Index is a tool to track market sentiment. There are seven indicators in the Index measured on a scale of 0 to 100. The Index is calculated by taking the equally-weighted average of each indicator.

These seven indicators in the Index are Put and Call Options, Junk Bond Demand, Market Momentum, Market Volatility, Stock Price Strength, Stock Price Breadth, and Safe Haven Demand.

Source: CNN Business

Economic News

The US Bureau of Labor Statistics reported the Producer Price Index increased a seasonally adjusted 0.8% in November. On an unadjusted basis, the final demand index rose 9.6% for the 12 months ending in November. This value is the largest increase since the government started calculating it in 2010. This reading follows an 8.8% increase for October. The PPI started the year off with 12-month price growth of 1.6%.

The Commerce Department reported advance US retail and food services sales increased 0.3% to $639.8B in November, following an upwardly revised 1.8% in October. Retail sales are 18.2% higher than a year ago. Total sales for September 2021 through November 2021 were up 16.2% year-over-year.

In its policy statement, the Federal Reserve forecast a much quicker end to its monthly asset purchases. According to the policy statement, the decision to pivot by the Fed was made “in light of inflation developments and the further improvement in the labor market,” according to the policy statement. As a result, Fed officials project as many as three quarter-point rate increases in 2022.

Thanks for reading The Fed Pivots – Week in Review!

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Prakash Kolli is the founder of the Dividend Power site. He is a self-taught investor, analyst, and writer on dividend growth stocks and financial independence. His writings can be found on Seeking Alpha, InvestorPlace, Business Insider, Nasdaq, TalkMarkets, ValueWalk, The Money Show, Forbes, Yahoo Finance, and leading financial sites. In addition, he is part of the Portfolio Insight and Sure Dividend teams. He was recently in the top 1.0% and 100 (73 out of over 13,450) financial bloggers, as tracked by TipRanks (an independent analyst tracking site) for his articles on Seeking Alpha.

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