Challenges to watch for: Market Musings
We have all heard of a pending Fed Pivot, the anticipation of the Fed’s Board of Governors going on hold with additional interest rate increases due to the risk of an economic recession. A pivot would be a change of course based on the Fed’s assessment that the economy may be slowing. Many economists believe it takes 18 months for the full effect of a Fed rate increase to be felt economically. Accordingly, rate increases made during 2022 may not be fully felt until summer 2024.
But what else is lurking in the future that may impact our daily lives other than a macro event like a Fed Pivot?
Scenario 1: Saudi Arabia continues with its recently announced cut in oil production and delivery of product to the U.S., but also begins selling U.S. Treasuries along the way.
This recent development compounds the complexity of the 40-year relationship between Saudi Arabia and the U.S. where previous military aid was granted by the U.S. while the Kingdom was instrumental in buying Treasury bonds to fund our deficit spending. However, the recent killing of Jamal Khashoggi, along with an indirect benefit to Russia via the scaling back of oil production by the Kingdom, has led some in Congress to consider an antitrust suit against the Kingdom, as well as discussion of Economic Warfare.
Warfare? Yes. Should the Kingdom (in response to an antitrust suit or for other reasons) decide to sell treasury bonds, of which they hold a significant amount (the worlds 16th largest holder), the impact could be meaningful. This is a scenario to watch for. The Bond Markets yield curve may feel like a mysterious animal, but it does not need to be. Please click the link above and note that the yield curve tells you your yield (Y axis) for a given maturity (X axis). Pick any date and take a walk back in time.
Consider early 1981. It was bananas! Just like in any market, when additional supply comes in the form of increased volume, prices decline. Given that bonds have fixed coupons that do not change, when the price goes down, the yield goes up and vice versa. Accordingly, if the Kingdom were to decide they want to compound the already significant financial pain felt in the U.S. by high energy prices, and a higher yield curve, intentional heavy treasury bond selling would (all else being equal) move the yield curve even higher for the maturities they are selling (think 2 year or 5 year bonds). Bond market participants know that to spur economic growth, a lower rate environment is more conducive to growth. The Kingdom intentionally selling treasury bonds could have (for a time) a noticeable impact on the bond market. I’m no expert on this topic, but it seems to be a plausible scenario that we may have to wrestle with.
A more plausible Scenario 2: China’s President Xi Jinping reverses the Zero-Covid policy, opening China’s ports and economy — and a more routine life in China resumes.
The Chinese New Year begins late January 2023. For over two years, Xi Jinping has insisted on a Zero-Covid policy. This led to a significant slowing of China’s economy. If I had to guess, due to the apparent decreased severity of a Covid-19 case, it’s plausible that Xi announces a new phase for China, allowing citizens to begin a re-emergence from lockdown before late January of next year.
Think of the downstream effect, specifically in energy and commodity prices. A likely domino effect would be increased consumption in China. It seems plausible that, as a result, energy prices globally could get even higher.
Could this cause the Fed to perceive a need for additional Fed Funds rate increases? That seems like a reasonable scenario to me.
If the above two events happen in concert, we may be dealing with a Fed that takes short-term rates higher and for longer than currently expected.
What’s the “So What”?
The push and pull on inflation is an inequality between supply side (goods and services pricing) and consumption (strength in demand or lack thereof). Recent Fed activity would likely affect the supply side (price for oil) less than the demand side, resulting in layoffs and individual insecurity.
An increase in commodity prices due to China’s re-emergence, compounded by a higher yield curve and additional Fed activity, may amplify the impact of an overactive Fed. Killing the demand for goods and services by stopping the economy will not directly impact the supply side of the equation, which is cause for concern. How far will the Fed go before the Pivot is announced? It’s unclear, but secular inflation of 4% due to limited supply-side constraints may not be tamped down, as the demand side weakens. It’s likely to be a challenging situation to navigate, that’s for sure.
While you wrestle with these and other risk-based questions, the Investor Relations team at Spartan has built and made available a complementary excel file designed to assist investors in the management of a portfolio of Private Investments. It can be found on the investor portal by clicking Open Investments, then click into any short-term Private Note listed. Incidentally, our private notes now pay two points up front.
I mention all this as architecting an expanding stream of active and passive income as we move to and through financial independence is a likely theme for us all. Feel free to download this tool, read the FAQ Tab, enable the Macros (it’s not nearly as scary as it sounds) and scratch your long held itch by doing some rudimentary financial planning done DIY. A truism I have found is anxiety comes from not doing the things I know I should be doing. If doing some DIY financial planning has been on your to do list for a while, this is a great way to start.
Layer onto this theme of planning the information that will be presented in our upcoming First Friday Meetup, in person RSVP here, click here to attend virtually, this coming Friday November 4th. Permanent insurance advisor Austin Dean of Waystone Advisors will be in the Seattle office presenting at this event. Future events playing off this topic will be an estate planning attorney speaking at a high level regarding generation skipping trusts, pending roll back of the Unified Tax Credit in 2025 and other relevant estate planning tactics to be aware of.
Please reach out to investors@spartan-investors.com with questions, we are always happy to help.
Published by Ted Greene
