Right now, the volatile equity markets hinge on two macroeconomic factors: inflation and interest rates. And they are directly intertwined.
The U.S. government printed more than $6 trillion in its response to the COVID-19 pandemic. As we would expect, this has sparked the highest bout of inflation in three decades.
The Consumer Price Index (CPI), which tracks the price of a broad range of goods and services, increased 7% from December 2020 to December 2021. This was the largest annual increase since 1982.
And I suspect that we have felt this big spike every time we go to the grocery store or out to our favorite restaurants. Prices are noticeably higher across the board.
We see it at the gas station, on our electricity bill, in rising labor costs… we see it everywhere.
So should we be worried about the current economic climate? In today’s essay, I’ll share my thoughts… and one big opportunity we shouldn’t miss among the noise.
Testing the Waters
The way the Federal Reserve (the Fed) can combat inflation is to increase interest rates, by raising the Federal Funds Rate. This is the rate at which banks can borrow and lend their excess reserves from each other overnight.
Raising the Federal Funds Rate would cause rates on consumer loans and credit cards to rise as well. This would slow down consumer purchases and thus economic activity.
If aggressively raised, this would cause inflation to fall back down to more acceptable levels.
The Fed has already threatened to raise interest rates three or more times this year. It also announced plans to stop buying mortgage-backed securities (MBS).
This would likely cause mortgage rates to jump overnight.
In fact, the spread between the Fed Funds rate and 30-year fixed mortgage rates would pop, causing severe dislocations in the housing market.
This would be a disaster.
These aggressive statements from the Fed have caused the market pullback that we are seeing right now.
As I write this, the S&P 500 is down about 7% from its all-time high. And the Nasdaq Composite is off about 13% from its high.
But here’s the thing… it’s clear to me that the Fed is just testing the waters with these statements for a reason.
The midterm elections are coming up in November. I do not think the Fed will aggressively raise interest rates heading into the midterms.
Doing so would cause the stock market to crash, which would be bad for the party in power. As such, the Fed will face a lot of pressure to not raise rates aggressively this year.
And that could mean good things for the stock market…
What History Tells Us
This situation reminds me of the Fed-induced market crash back in the fourth quarter of 2018. If we remember, the Fed raised rates seven times in 2017 and 2018. This culminated in the S&P 500 dropping 20%.
But then the Fed was forced to back off, and the stock market went on an absolute tear…
As we can see, the S&P 500 more than doubled after the Fed backed away from its interest rate increases in 2018. And that’s exactly what I expect to happen this year.
My prediction is that the Fed will raise interest rates one time (and definitely not more than two). It will likely be a small 25-basis point increase.
After that, the Fed will stay put through the midterm elections.
It will, of course, talk a big game about future rate hikes if the data warrants them… but we won’t see any aggressive action until after the elections.
Where Do We Go From Here?
We could see a little more weakness in the market in response to the first rate hike. But we won’t go much lower before institutional investors realize that the Fed is bluffing.
That’s when they will step in and buy stocks en masse.
That said, if the Fed does in fact follow up with its threats of aggressive rate hikes, it will be very bad for the market.
But keep in mind that these would need to be sizeable rate hikes to have any kind of impact. If the Fed simply increases the Fed Funds rate by 25-basis points three times, that still leaves the rate below 1%.
That’s still nearly free money.
If readers think that the Fed will truly raise rates by 200 basis points or more, now is the time to take profits and step aside. The markets will get ugly if that happens.
But I don’t think it will.
My one big concern, however, is that the Fed will halt its MBS purchases – that’s a very real risk.
Simply put, the Fed has been backstopping the entire mortgage market with these MBS purchases. That’s why mortgage rates have been sub-4% on primary residences for prime borrowers.
With the Fed buying up the mortgage-backed securities, lenders basically have no risk. They can originate loans at low rates and push them on the Fed.
However, if that dynamic ends, we would see a major disconnect between the Federal Funds rate and 30-year mortgage rates. By that, I mean mortgage rates would rise much faster than the Fed Funds rate.
This would be bad for the mortgage industry and the economy, and it could be absolutely devastating to people with adjustable mortgages.
One recommendation for those who have not done so yet – lock in a 30-year fixed mortgage on your primary residence or investment properties. In time, the interest rates will go up, so locking in these incredibly low rates is a very smart thing to do.
In fact, it is one of the smartest things anyone can do to “fight” the kind of ridiculous monetary policy that we are witnessing today.
And there’s also one other opportunity on my radar that I don’t want investors to miss out on in 2022…
I’m preparing an exclusive private briefing to tell readers all about it. If anyone has lost money in the recent market volatility, this will be especially important for you…
In this briefing, I’ll explain how we should play the current markets – buy? Sell? Hold?
And I’ll also reveal my new 100X plan for profiting from a huge technology trend in 2022 – including the name of one stock that could be an easy double this year.
So please plan to join me on Wednesday, February 16, at 8 p.m. ET.
If you haven’t already, you can quickly RSVP by going right here.
I hope to see you there!
Editor, The Bleeding Edge
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