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It's the Fed stupid

by , 14 July 2022
It's the Fed stupid
The US Fed is a main player in the world's financial system.

As the central bank of the world's largest economy, and thus the institution that controls the world's reserve currency, its rate decisions are always closely watched.

However, in the current high inflation environment, it takes on an extra level of significance. I would go as far as to say, that if you are looking to make any type of investment decision over the next few months, be it buying a property, moving cash offshore or adding to your stock portfolio, you will need to have a view on what the Fed is likely to do next.

The world markets are in a mess but we have just banked our 4th gain in a row! Here’s how…

The markets are in a mess thanks to a recessions outbreak around the world,  peaking inflation, crypto crashes and USD/EURO parity is playing havoc with SA exports.

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And this!


Here’s my view…

The Fed has historically acted earlier and more aggressively than the other major central banks. If you look at the Fed’s response to the Global Financial Crisis (GFC) of 2008. They were far quicker to employ extraordinary measures than the European Central Bank (ECB). The ECB eventually followed suit, but the delay cost them dearly. The US recovered sooner, and the Fed didn’t have to use as much monetary stimulus as the ECB eventually employed.

This time around is no different. The Fed has raised rates faster and higher than other major central banks. Not just the ECB but also the Bank of England (BoE) and the Bank of Japan (BoJ). If they’re right, not only will the US likely get inflation under control first, but they will also be able to bring rates down quicker as well.

The one difference between this crisis and the GFC is that the Fed will be raising rates rather than lowering them. Raising interest rates is a far less popular policy path. It raises costs for firms and individuals. And ultimately it will cut economic growth. It will be far easier to maintain its current aggressive rate hiking policy stance if it could use economic data to justify its stance.

Is stagflation on the horizon?

One key piece of data was released yesterday, 13 July 2022.

It was the US CPI figure for June 2022. This CPI reading was much higher-than-expected. The print came in at 9.1% versus an expectation of around 8.6%. That’s the highest inflation number in the US since 1981. Not only does this show that US inflation has not peaked, but it’s also showing the market, while very worried about inflation, is still underestimating the problem. If we don’t see some level of moderation soon, the Fed may be forced to raise rates even more aggressively.

The next key data point you need to look out for will be second quarter GDP growth on 28 July 2022. The first quarter showed a surprisingly large drop.
Luckily forecasts are for a recovery in the second quarter. However, if we get a disappointing reading, it would then raise the spectre of true Stagflation.

Stagflation is one of the worst possible scenarios for financial markets. Just look at US market returns for the 1970s. That was the last time we faced stagflation. Virtually every financial asset class performs poorly during periods of stagflation.

How do you as an investor exploit the situation?

Luckily, there are still ways a savvy investor can exploit this situation. You might believe, in times of high inflation, I would be suggesting you turn to a physical asset like property. You might think that if paper money is worth less, then a physical asset like property would act as a store of value.

Unfortunately, while inflation should assist physical assets, property prices are largely dependent on income levels.

As businesses are forced to scale back, consumers tighten their belts and mortgages become more expensive, the property sector is likely to languish even as the general price of goods and services increase.



The Holy Grail of Income Investors


I’d suggest looking at mature companies that pay high dividends.

Firstly, mature companies tend to have established “moats”.  They’re often the leading player in an established sector and incredibly hard to dislodge by new entrants.  

Secondly, their cash flows are usually more predictable than the more speculative segments of the market. This means their earnings are usually more secure in tougher markets.

Finally, if they have an established dividend policy, and a strong history of rewarding shareholders, you have a better chance of being rewarded in a difficult environment.

But a word of caution. All dividend stocks are not equal. Many people assume all stocks with high dividend yields are safe. Remember a dividend yield is the dividend paid divided by the share price. If the stock price has recently collapsed, the dividend yield may be artificially inflated, and the company may be on the cusp of cutting its dividend.


It's the Fed stupid
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