"Interest Rates Take Flight"

MONETARY

• The Federal Reserve proceeds to hike the Fed Funds Rate by 50bps from a level of .25-.50% to a new level of .75-1.00%. This was the second interest rate hike in the Fed’s current hiking cycle, and was the first 50bps hike since 2000⁴
  • Regarding the Federal Reserve’s approach to reducing the size of the bank’s Balance Sheet, it was again noted that a much faster pace of asset runoff would be appropriate relative to prior normalization efforts in 2017-2019¹
    • Additionally, Fed participants noted that balance sheet runoff was to commence at a monthly reduction pace of $60B for Treasury holdings, and $35B for MBS holdings, which is to be phased in over a period of 3 months¹
    • It was generally agreed upon that phasing in these reduction limits over the course of 3 months would be likely be appropriate to give the Federal Reserve flexibility to address any potential market functioning disruptions¹
    • Participants also agreed that the composition of the Federal Reserve’s holdings, on a post-normalization basis, should primarily consist of Treasury holdings, and that it may be appropriate at some point to implement a formal policy for selling MBS holdings outright¹
    • It was also noted that any potential disruptions to money markets caused by balance sheet normalization could be addressed by the Federal Reserve’s Standing Repo Facility (SRF), which did not exist during the 2017-2019 normalization effort¹
  • Another interesting observation from the recent FOMC Minutes release revolved around the concept of market liquidity¹
    • It was noted that Market Depth (a measure of trading liquidity) became strained during the past month, and was seen as a large factor in exacerbating recent volatility in both the Equity and Treasury markets.¹
  • Regarding aggregate economic activity, Fed participants noted that across the board measures of economic activity and employment continued to strengthen during the past month¹
    • Recent large employment gains contributed to a decrease in the overall unemployment rate¹
    • Additionally, participants noted that Inflation still remains above the Federal Reserve’s long-term goal of 2% primarily as a result of continued supply-chain disruptions, as well as higher energy and commodity prices attributed to the Russian invasion of Ukraine¹
  • The minutes also show that many participants suggested that multiple 50bps increases could be appropriate if Inflationary pressures remain elevated, but also that significant tightening had already occurred in longer-term rates as the market readjusted policy expectations¹
• Pursuant to the April release of the Federal Reserve’s Beige Book, the Fed noted several observations regarding the current state of economic growth, labor markets, and inflation backdrop¹
  • In the aggregate, economic growth was noted as having accelerated at a moderate pace on the back of increased Consumer spending, although growth was seen as continuing to be constrained by low inventories related to various supply chain disruptions¹
  • Regarding Labor Markets, overall employment was seen as having increased moderately across the board, however a continuation of worker availability did impede hiring efforts¹
    • Very important to note, several districts did report that the available worker shortage was continuing to improve, which is consistent with prior Beige Book observations as well¹
  • Inflationary pressures were seen as remaining elevated, with higher input costs being swiftly passed through onto end consumers. Some contacts in various districts did report negative effects to sales from rising price though, an indication of consumer substitution effects taking place¹
    • Raw materials, transportation, and labor costs were seen as having rose substantially. Energy, metals, and agricultural commodities were seen as having been particularly effected by the Russian invasion of Ukraine¹

 

FISCAL

• As part of the Bipartisan Infrastructure Law enacted in 2021, the Biden Administration announces $3.1B in funding to support domestic production of electric vehicle batteries and related components¹
  • The fund will go to U.S. companies to aid in the development of new factories, as well as in the retrofitting of existing factories to accommodate battery production¹
  • (Energy Secretary – Jennifer Granholm) “will give our domestic supply chain the jolt it needs to become more secure and less reliant on other nations,”¹
  • The Biden Administration has set a goal for fully electric vehicles to constitute half of all new vehicle sales by 2030¹

 

GEOPOLITICS

• In response to the ongoing Russia-Ukraine conflict, President Biden requests congress to approve a $33B aid package, aimed at providing additional support to effected regions of Ukraine¹
  • The request for aid has hit an impasse in congress, as Republican lawmakers protest linking the $33B request for foreign aid to an additional request of $10B for additional Covid relief efforts¹
    • Republican lawmakers have expressed a strong desire to decouple the initiatives and would largely prefer to approve the $33B foreign aid package as a standalone bill¹
• The European Union formally proposes to ban all Russian oil imports. Russia is the largest exporter of oil to the European Union, having accounted for roughly 27% of all oil imported to the E.U. in 2019¹
  • The oil ban will be phased in over a period of sixth months, and the ban on refined oil products will be phased in before the end of 2022. Important to note, the proposed ban will require the approval of all 27 member countries¹
  • The oil ban does not include natural gas imports from Russia, which are seen as being much more challenging to replace on a long-term sustainable basis¹
    • The European Union gets roughly 30-40% of its natural gas imports from Russia. Currently, E.U. member countries have been focused on building up their respective natural gas inventories to hedge against the possibility of future supply disruption¹

 

MISCELLANEOUS

• Partial lockdowns in two of China’s largest economic centers, Beijing & Shanghai, continue despite some easing measures being taken in recent weeks¹
  • The city of Shanghai has been subject to various lockdown restrictions for the past 2 months, but has recently taken measures to ease restrictions such as allowing specific companies to resume operations¹
    • The number of individuals in Shanghai who are subject to stay-at-home orders is now 2.5M, down from 5.3M¹
  • However, Beijing has been recently ramping up lockdown restrictions by instituting a number of measures which include shutting down theme parks and banning dining in restaurants¹
    • Beijing has also conducted several rounds of mass testing, and will require that weekly testing be conducted for any persons looking to utilize public transit, or enter public spaces such as supermarkets¹

 

[See Below for Disclosures & Annotations]

DISCLOSURES

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are un-managed and may not be invested into directly.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

The companies presented here are for illustrative purposes only and are not to be viewed as an investment recommendation.

Tax laws and regulations are complex and subject to change, which can materially impact investment results. LPL Financial does not provide tax advice. Clients should consult with their personal tax advisors regarding the tax consequences of investing.

 

ANNOTATIONS

1. The Federal Reserve. “Minutes of the Federal Open Market Committee: March 15–16, 2022”. April 6, 2022
2. The Federal Reserve. “The Beige Book: Summary of Commentary on Current Economic Conditions”. April 20, 2022.
3. CNBC. “Biden administration announces $3.1 billion to make electric vehicle batteries in the U.S.”. May 2, 2022.
4. Federal Reserve. “Federal Reserve issues FOMC statement”. May 4, 2022.
5. CNBC. “Biden’s $33 billion Ukraine aid request hits early snag over Covid funding in Congress”. April 29, 2022.
6. NPR. “The EU just proposed a ban on oil from Russia, its main energy supplier”. May 4, 2022
7. CNBC. “Beijing city closes gyms and bans dining in as Covid controls tighten”. May 3, 2022