[00:00:00] You're listening to First Forward Podcast by First American Bank, where we bring you business and investment insights designed by our team of experts to help you meet your financial goals. Here's our host for today's episode.
David Lackmann: Welcome to everyone listening today. And thank you for tuning in. My name is David Lackmann, director of investments for First American Bank Wealth Management in Florida. And I'll be your host for today's podcast, where we're gonna be discussing rising interest rates, fighting inflation, and most importantly, how to navigate those challenges with me today is Mike Adkinson, director of fixed income and portfolio management for first American bank wealth management.
David Lackmann: Mike, thanks so much for joining me today.
Mike Adkinson: My pleasure, David.
David Lackmann: Hey Mike, so let's get right into it. We are experiencing the highest inflation we've seen in golly, over 40 years here in the US anyway, um, there are crazy prices at the gas pump, higher prices in the grocery store, restaurants, clothing, you name it, everything just [00:01:00] seems to be costing more and people are paying higher rents, you know, by sometimes 20, 30, even 40% housing prices are through the roof. And, and quite honestly, just everything seems to cost more. Mike, I think you and I would both agree that things aren't great with respect to the health of our economy. As of today, I know that, uh, we just had a couple economic readings and they're a little bit better this month, but it's still not great. So to battle inflation and in an effort to turn the economy around the federal reserve has raised interest rates several times this year, and most recently raised the overnight lending rate by 75 basis points in both June and July.
David Lackmann: Those are the two biggest rate increases we've seen in, you know, decades, as I'm sure you're aware. How does raising interest rates lower or fight inflation?
Mike Adkinson: David the main thing um, the fed looks, to [00:02:00] interest rates through raising the, the rate on the fed funds rate that will in turn increase, say the prime rate that clients or the banker are charged.
Mike Adkinson: It also has an impact on, you know, the rates on loans, adjustable rate, mortgages, credit cards, et cetera. So with higher interest rates, demand is somewhat squelched a little bit. And that's what the key for driving to drive inflation down is, is to get the demand below where it is currently for anything from energy, housing, cars, et cetera, takes money out of the system.
Mike Adkinson: So you hear about the federal reserve, draining liquidity from the system they're raising the fed funds rate. As you said, David, they've already done that. Yes. Three times this year, 50 basis point hike in May followed by 2 75 basis point hikes one in June and one in July. And the next fed meeting is not until late September where it's anticipated right now it will be another bump of either 50 or 75, [00:03:00] depending upon some of the economic data that comes in between now and then.
David Lackmann: All right. So essentially they're raising the cost of money. You know, if you think of interest rates as the cost of money, they're essentially making money more expensive for people to get loans, buy cars, do those kinds of things.
David Lackmann: And by doing that, it kind of slows the velocity of money. Does raising interest rates affect the stock market or even the bond market. What does it do to those two asset classes? When interest rates begin to rise?
Mike Adkinson: Well, this year we've seen the impact of inflation expected growth, slow down, both here in the US and internationally impact the stock market. Plus, you know, as the fed rate was raising rates that impacts the market as well. You look at stock valuations and discounting, future cash flows. You're now using higher interest rates to look at those numbers and those numbers come down. That's why sometimes you hear, in the financial press, you know, when interest rates are moving up it's the high, multiple stocks, the high PE stocks [00:04:00] that are hit the worst. Cause the higher interest rates using the valuation models impacts the longer term price numbers from that. And we saw that this year is the NASDAQ came down heavily, but what we haven't seen in a long, long time with the fed being very aggressive as they have been this year has been really the decimation of the fixed income market.
Mike Adkinson: We haven't seen the first half of a year, like we have in 2022 for over 40 years, the, you know, the Bloomberg aggregate bond index, which measures all the investment grade bonds here in the US, you know, treasuries, corporates, et cetera. It's about 10% by June 30th. And that is just a huge number for the bond market.
Mike Adkinson: And the bond market was actually sniffing out the fact that the federal reserve was gonna have to be more aggressive in raising rates as what were known as the short term interest rates. Those anywhere from three months to two to three years, started to rise at the beginning of this year, before the fed even started to raise rates.
Mike Adkinson: Now give you an example, uh, right about a year ago, the [00:05:00] two year treasury deal was .21% As of today, it's 3.21%. And that really accelerated from December and on as inflation numbers started to get larger and larger. And we heard the comment that it was transitory, but as we got into spring and summer, and of course the situation in Ukraine, uh, did not help with some of the supplies of, you know, energy, agricultural project, et cetera, that sort of exacerbated the problem a little.
Mike Adkinson: So we saw interest rates climbing, even higher. We saw the CPI and the PPI two measures of inflation continue to accelerate higher. And that's when the fed started to get even more aggressive going from a 25 basis hike point all the way up to 75 basis point hike.
David Lackmann: I mean, it sounds like bond investors, new money would be winners on the losing side or people that are borrowing money that are trying to get mortgages, you know, just cause things are gonna be more expensive from a, from a credit standpoint.
David Lackmann: It, I mean, would you have that same assessment? There are winners and losers [00:06:00] when, when rates are going
Mike Adkinson: Yes. So when rates are, when rates have gone up this much, obviously the winners will be the savers folks who have been wanting to purchase a CD for the last couple of years. And then, you know, when the federal reserve cut the fed fund rate down to 0.25%, right at the beginning of COVID and kept it there, money market funds, certificates of deposits, even even short term treasuries were basically yielding very, very little. So that was really bad for savers and those trying to invest on the other hand, during that timeframe, if you were a borrower, it was fantastic because the rates were incredibly low, you know, corporate America, the S and P 500, and we almost completely reworked their balance.
Mike Adkinson: It's getting rid of older, higher level debt, issuing new debt, you know, with coupons, you know, in the 0.61 and 1.5 and 2% range so if you were a borrower and you borrowed a lot and locked in of those low rates, that the long run could have been a bit more beneficial. So now the savers are getting a little bit of benefit now with rates higher, as for [00:07:00] bond investors, new money, if you haven't had money in, or you've been a CD investor, and you look, you could look now to start going into individual bonds, you're doing a lot better.
Mike Adkinson: Unfortunately, the folks that held bond funds, who, you know, through the course of almost the last 20, 30 years rarely saw a bear market in bonds, or rarely saw a year with negative returns in the Bloomberg aggregate index saw, well, say one of the worst starts to year in over 40 years with, with a negative return.
Mike Adkinson: So even higher rates to bond funds, uh don't mix.
David Lackmann: Do you think the fed will need to continue to be as aggressive as they have been to continue to try to thwart inflation? You know, here in the short term.
Mike Adkinson: David that's, that's truly the couple of trillion dollar question that everybody is asking right now.
Mike Adkinson: Cause the fixed income market is looking at every single economic data point that comes out microscopically. Last Friday, we had the jobs number, which was [00:08:00] twice that of expected and the bond market did not like that. We are almost in the, the timeframe now where good economic news, which means the economy is strong, is bad news for the fixed income market, because that means the fed has to continue on its pace of raising interest rates to slow the economy down. You know, conversely, oddly enough, good news sometimes can be bad news as well that way. But what we've seen now, even though we had the PPI and the CPI just come out and they were a little better than expected, but the numbers are still high. You still have the federal reserve numbers going out there still saying that they're gonna need to continue to raise rates, especially to look at the core inflation.
Mike Adkinson: We always look at the CPI headline number and that's with food and energy and that's obviously energy's kept that number up very high, but the core CPI number the year over year number was last was a, was a 5.96. Whereas estimate was gonna be 6.1. That's still very high. So the fed is gonna continue to do so and the argument that the bond market [00:09:00] and the stock market are having almost on a daily basis is, when is the fed gonna think they've done enough to where they can either slow down or you can start to see an end in sight to their rate hikes with a couple of bad, uh, economic numbers the bond market responds almost thinking, okay, well now the feds has to be done and then you have a couple of good numbers, and then the bond market says, well, I guess the feds not near done and bond sell off. And so we've had that extreme kind of volatility here over the last few months and the bond market simply cause the bond market investors, ect cetera have been going from the economies to hot still now, it's cooling off. The inflation was good, job markets were good, et cetera. Today, even the bond market is saying that we've still got a ways to go. Cause even with the CPI and PPI numbers that were better than expected, the bond market is selling off and rates are moving back up higher.
David Lackmann: Is there a point where the fed does too much or tries to do too much?
Mike Adkinson: Yeah. Well, anytime that the fed has gone on a [00:10:00] spade of where they've been raising interest rates to sort of quell the economy and slow it down. Obviously we haven't seen inflation rates this high, so this is really sort of an anomaly in terms of rate hiking measures. You know, that's sort of the standard measure.
Mike Adkinson: You're as to raise rates just enough to where we slow the economy enough to re keep inflation in check and everything's perfect. It is threading the needle in an economy that is so big, so diverse with constantly changing, purchasing patterns, saving patterns of all of, you know, all of the, uh, constituents here in the United States.
Mike Adkinson: So it's, I see, it's very tough to land that plane, as I say, a soft landing to get it just right cause of things are so different. Cause you've got other factors on the outside as well, energy prices that are global in nature, political issues of that stuff. So it's, it's always been a tough one. There are some things that, that are out of the Fed's control. So there are things in this, in this economy that are slowing a little bit because of what the Fed's done. And then there are things that are outside [00:11:00] of the Fed's control.
David Lackmann: Yeah, that makes perfect sense. Hey Mike, thank you so very much for joining me today. It was a pleasure and the opportunity to pick your brain a little bit.
David Lackmann: Thanks again for listening everyone. And until next time, this has been a First Forward Podcast from First American Bank Wealth Management.
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