Inflation + Fed Funds Rate + 10-Year Yield —> looking back 12 months
It’s been a long time since there’s been this much public interest in financial headlines. In a sports betting type of atmosphere, we’ve all been glued to the news as if monthly inflation prints were Monday Night Football and the Fed reaction were the Wildcard Playoffs. Lost in the shuffle of monthly attention-grabbing headlines is a much needed short-term historical look-back on what’s been a wild ride over the last 12 months. To put things in better perspective, my team assembled a chart of three major indicator I pay attention to most: annualized monthly inflation readings, the Fed Funds Rate and the 10-year yield rate. All are helpful data points as we consider macroeconomic directional movements and micro issues like the financing costs of real estate projects.
It’s important to remember that Inflation started last year with a mere 1.4% reading in January ‘21. From there, it quickly ripped higher into the 5% range by May ‘21. What’s even more astonishing than the quick jump is the Fed’s massively delayed reaction. For the entire second half of 2021, the Fed stuck by its infamous “transitory” inflation call, waiting until March ‘22 to begin lift-off, a full 12-months after inflation first crept over their target 2% rate in March ‘21. By the time they first raised rates, inflation was already above 8%. From time of its first rate hike, the Fed then went atmospheric, launching consecutive monthly 50 - 75 bps hikes from April ‘22 through July ‘22, taking its rate quickly up to 2.5%. All efforts were behind destroying demand and quell rising prices despite little ability to control certain inputs like food supplies, energy prices and supply chain lock-ups. With another strong 8.5% reading in July ‘22, just 0.6 percentage points shy of the previous month’s high-water mark, it can only be expected another 75 bps hike is headed our way in September ‘22.
The 10-year Treasury yield has been another curious metric to follow during the roller coaster ride of 2022 YTD. The yield is a major setting point for all types of loans from residential mortgages to larger commercial loans. Beyond it’s utility in the financing world, it also tells a different story from the ever-prescient and forward looking bond market…. or the “smart money” as some investors call it. The 10-year yield is often seen as reflective of future economic growth expectations and corresponding interest rate activity. To see it rise so swiftly then plateau the last few months tells an interesting story of this tightening cycle: the Fed lost credibility with it’s “transitory” call in 2021 and in order to save face and kill the hugely unpopular inflation bug, it basically had no choice but to march ahead with rate hikes even as the economy began slowing. The first rate hike came as the economy ended the first quarter of 2022 with a negative growth reading. With now a second negative GDP quarterly reading in a row and recession talk full blown, a wavering 10-year yield might be telling us both the economy, and the future Fed Funds Rate, might be on the slide downward sooner than most expect.
A yield curve inversion is typically measured by the spread between the 2-year and 10-year yields. As of this writing, the 2-year stood at 3.175% and the 10-year at 2.77%, a negative spread of -40.5 bps. It’s been foretold a million times that an inverted yield curve typically portends a recession. And here we are with a Fed saying it wants to get to a 3.5% Fed Funds Rate by 2023, a mere 100 bps away, at the same as GDP growth is slowing. By that point, a clear inversion may stretch across the entire yield curve, putting the Fed in a tricky spot of sticking to its guns on inflation, should the need still exist, or falling back to it’s old ways of being the “market put” investors have become accustomed to seeing it be. On a day when the NASDAQ surged nearly 3% after experiencing relief from “just” a 8.5% July ‘22 inflation reading (peak?), it seems like investors are banking on this later scenario to be the case.