As the Federal Reserve attempts to navigate through the fog of a trade war, Jerome Powell recently announced the latest decision to stay put as the Federal Reserve continues its “wait and see” approach to interest rates.
With one year left in his term, Powell continues to thread the needle between taming inflation while bolstering the economy. Despite the recent correction in the S&P 500, Powell shared that the underlying economy remains strong. However, he hinted at concerns that have been making their way through the news cycles over the past month.
In this article, we’ll examine Powell’s decision along with the latest yield curve movement and what that could mean for investors.
What the Fed Revealed in Their Latest Meeting
The outcome of the March meeting is that nothing has changed – for now.
Despite the recent concerns amidst the stock market dip, we believe that the underlying economy remains strong:
- The labor market continues to be resilient.
- Economic activity and GDP finished strong in the 4th quarter of 2024 and are expected to rise (albeit at a slower pace).
- Inflation continues to sit above the 2% target; while it has made progress since last year, the latest reading has inflation stubbornly at 2.8%.
For these reasons, the Federal Reserve is staying put with interest rates held steady at 4.25% to 4.50%. Powell revealed a plan to slow down the Federal Reserve’s balance sheet from $25B to $5B, which could put less upward pressure on long-term interest rates and reduce strain on the economy as the fight against inflation continues.
Inflation has been the buzzword for the past year. After peaking above 9% (the highest since 1981), the CPI has reached a more manageable level, though still higher than the Fed would prefer. This persistent inflation has been a battle since Powell began his term, though the circumstances driving inflation are very different now than at the start of his term.
Is This a “New Normal” For Inflation?
The last time Powell used the word “transitory,” the world was working its way through COVID lockdowns, which led to a rapid increase in consumer spending along with systemic supply chain issues.
In 2021, inflation was brushed off as “transitory,” though it proved anything but – it would continue to increase and remain at the highest level in nearly 40 years. Now, the word “transitory” is making the rounds again, however, under a very different set of circumstances.
The main headwind to lowering inflation this time is tariffs.
Tariffs levied on imported goods are passed onto the consumer, leading to a rise in prices. The Trump administration is no stranger to tariffs (they were used effectively in his first term and continued in the Biden administration); however, so far in his 2nd term, the President has used them as a bargaining chip that has yet to be implemented to its fullest extent.
The threat of tariffs is enough to make consumers and suppliers nervous, which could lead to higher expectations baked into prices and an uptick in inflation as a result. That said, the Trump administration, including Treasury Secretary Scott Bessent, insists that tariffs would only lead to a temporary bump in inflation and not lead to another round of the price hikes we just exited:
“I would hope that the failed ‘team transitory’ could get back together and think that nothing is more transitory than tariffs,” Bessent said at a luncheon in New York.
What’s Happening With the Yield Curve?
What the news cycles say is one thing, but when we look at the yield curve, we see a different story.
As of this time last year, the yield curve was inverted with higher yields for short-term maturities. In the fall of last year, the yield curve un-inverted, but now it’s a different story: the yield curve is sagging in the middle as short-term maturities rise once more while the 10-year yield has sunk below the 3-month yield.
One explanation for this is that investors anticipate slower economic growth and faster inflation. The challenge here is one of dueling goals and policies: on one hand, the Trump Administration wants to see long-term yields drop to lower borrowing costs and spur growth; on the other hand, that could spur inflation further and revive fears of stagflation.
What This Means for Investors
No one has a crystal ball. We can’t predict the future, but we can prepare for it.
Despite the dour tone in the news recently, there are underlying strengths to the economy and wheels in motion that could lead to increased economic growth in the future.
As Warren Buffett says, the stock market is a voting machine in the short run and a weighing machine in the long run. Amidst a change in Administration and policy, the voting machine may feel a bit off-kilter for now, but that’s only in the short run. We believe that the best approach is to view your finances as filling up three buckets over the long run:
- Money you need now: This is your immediate savings that you need to access at any given moment. We recommend keeping this in the highest-yield money market account you can find. With interest rates staying put, you can still get 4% or more on a money market account.
- Money you will need relatively soon: These are funds you may need in the near future, but not at a moment’s notice. We recommend investing these in a Treasury ladder to lock in rates and avoid state income tax on gains.
- Money you don’t need for a while: This is money you invest for the long haul. We recommend a broad index-based approach to bet on the long-term growth in the economy.
Within that index approach, strategies such as direct indexing can allow you to harvest tax losses within an index to reap benefits along the way to your long-term investment plan. This is just one of the ways that M3 Family Office helps to shepherd our clients and give them the operating system to manage and grow their wealth.
If you are interested in evaluating your wealth plan, please contact us from our website.
This information is general in nature and should not be considered tax advice. Investors should consult with a qualified tax consultant as to their particular situation.
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