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STA Weekly Report – Inflation, Interest Rates, and Monetary Policy

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Inflation, Interest Rates, and Monetary Policy
Year-End Tax Planning and Financial Ideas
Weekly Snapshot of Global Asset Class Performance
401k Plan Manager  *Updated on 10/23/2018

The accelerating pace interest rate increases in 2018 has certainly caused some painful experiences for bond investors.

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The Federal Reserve has hiked the policy rate three times so far this year and is widely expected to bring the rate higher by another 0.25% in December. While interest rate risk has been in the news headlines since 2015, it did not materialize until 2018. Based on the Fed’s own projections, policymakers plan to further increase interest rates three times next year. This hawkish view has kept investors wondering, “are we entering a long-term bear market for bonds?”.

Source: Bloomberg

We believe that Fed is likely to slow down its pace of monetary policy normalization in 2019.

The U.S. Central Bank has two key objectives: maximizing employment and stabilizing prices. The first mandate has been achieved with the unemployment rate sitting at 3.7%. The Fed continues hiking rates because it worries that an overly tight labor market will eventually awaken inflation as wage pressure builds. Historically, an unexpected rise in inflation has forced the Fed to take an aggressive monetary policy stance and has often been blamed as the trigger for recession. However, recent economic data indicate that the historical link between employment and inflation has weakened significantly. Although the unemployment rate continues trending lower, the Consumer Price Index, Personal Consumption Expenditures, and most other measures of inflation have been drifting toward the Fed’s 2% target, after peaking in the summer. With declining oil prices and a softening housing market, there’s little evidence that the U.S. economy is in danger of overheating any time soon.

Source: Bloomberg

Market expectations of future inflation, as measured by breakeven points between nominal and TIPS Treasury Bonds, have also been cooling down.


Source: Bloomberg

The Fed generally aims to smooth the peaks and troughs of the business cycle by adjusting short-term interest rates. By lowering borrowing costs during a recession, the Fed stimulates consumer and business spending and helps manufacture an economic recovery. By increasing borrowing costs at business cycle peaks, the Fed puts a break on the economy to prevent overheating.

The Fed tends to be cautious raising interest rates when financial conditions are tight as the economy has a lower tolerance to increased borrowing costs.  For example, the Fed only increased rates once in 2015 and 2016 when financial conditions were not favorable. When financial conditions became accommodative in 2017 and 2018, the Fed continued hiking rates (purple line in chart below). Since October, financial conditions in the U.S. have quickly tightened, following the sharp selloff in stocks and a moderate widening of credit spreads in the bond market. Tighter financial conditions help cool down the economy. So, the Fed shouldn’t be pressured to hike rates at a rapid pace.

Source: Bloomberg

Make no mistake, we don’t believe the rate hiking cycle is over. But it is our belief that the Fed is likely to slow down the pace of rate hikes and take a more patient approach to normalizing monetary policy. A dovish Fed supports bond prices and potentially weakens the U.S. dollar, which in turn benefits emerging market assets, commodities, and U.S. large cap stocks that derive meaningful revenues from international markets. A more gradual rise in interest rates would also help some key economic sectors, including housing and auto industries, whose customers’ purchase behaviors are sensitive to borrowing costs.

Weekly Global Asset Class Performance

If you have any questions, please feel free to email me at


STA Investment Committee

Luke Patterson, CEO & Chief Investment Officer
Mike Smith, President
Andrei Costas, Senior Investment Analyst (Equity Strategies)
Nan Lu, Senior Investment Analyst (Fixed Income Strategies)

Written By: Scott Bishop, MBA, CPA/PFS, CFP®

The end of the year presents a unique opportunity to look at your overall personal financial planning situation.   With factors like the 2018 tax law changes, life changes or just working towards your goals, now is an especially important time to review things.  It is always a good time to see if you are  on-track at your stage in life. Taking what we now know about the new tax law and weaving together all of the other areas of your personal finances is one of the key ways we provide value to you as your trusted adviser. Below are some things we’d like to help you think through before the year ends.

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Important Disclosure

Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by STA Wealth Management, LLC (“STA”), or any non-investment related content, made reference to directly or indirectly in this article / newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this article / newsletter serves as the receipt of, or as a substitute for, personalized investment advice from STA.  To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing.  STA is neither a law firm nor a certified public accounting firm and no portion of the article / newsletter content should be construed as legal or accounting advice.  A copy of the STA’s current written disclosure Brochure discussing our advisory services and fees is available upon request. Please Note: If you are a STA client, please remember to contact STA, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. STA shall continue to rely on the accuracy of information that you have provided.






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