Weekly Market Update for May 5, 2023

by Jim Ulland

Is the Fed through raising interest rates? It sure seemed that way as both equities and fixed income surged on Friday. Right after Wednesday’s Fed announcement of a 0.25% increase in rates, the market sold off. Chair Powell implied they are finished raising rates but said they did not intend to lower rates later this year. The market thinks the Fed will be forced to lower rates to prevent a recession. The fixed income market seems to have reached a bottom from which a long recovery can begin. We see a tailwind in the fixed income market over the next 24-36 months as the Fed pauses and then reduces rates. Just as fixed income fought a headwind as rates rose, the next phase of the interest rate cycle may turn into a tailwind soon. We see a meaningful recovery in preferred stock prices by year-end, kicking off a multi-year rebound.

What could cause the Fed to lower rates? The primary reason the Fed has raised rates is to control inflation. They argue that if they slow the economy, wage pressures and other prices will fall in line with their goal of returning inflation to 2%. This week, crude oil fell 10% (now 26% lower than a year ago). Used car prices declined 3% from March. Job openings shrank. Unemployment filings increased. Prices and inflation continue to trend down. Each month that the CPI confirms this trend, there is less reason for the Fed to keep rates high. A second reason for the Fed to lower rates is that the rapid increase in rates has been destructive to banks. Six-month US Treasuries pay 5%, making the government a huge competitor with banks for deposits. The fastest rate increase in forty years also put losses in banks’ investment portfolios, scaring depositors, and resulting in the failure of three large banks. A pause in rate increases should reduce the turmoil the Fed created in the financial sector. This, too, would help fixed income prices recover.

We are offering a US Treasury strategy composed of short-term Treasuries that pay over 4.5%. As they say, “Get them while you can.” We expect Treasury yields to fall when the Fed reduces rates.

During the week, equities were boosted by a flow of corporate earnings that exceeded expectations. Equity investors also anticipate an interest rate reduction later in the year and are buying ahead of the news. More layoffs were announced, which will help rebalance corporate expenses with reduced revenue growth. This also will support stock prices.

Next week, worries about the government debt ceiling will intensify. We expect Congressional agreement to be reached…at the last minute, as has been the pattern. Even with all the trauma in the financial services sector, the market ended relatively flat for the week. The S&P 500 was -0.80% and NASDAQ was +0.07%. Monday the S&P 500 was -0.14%, Tuesday -1.16%, Wednesday -0.70%, Thursday -0.72%, and Friday +1.85%.

The information contained in this commentary is not investment advice for any person. It is presented only for informational purposes to assist in explaining factors that may have had an impact in the past or may have an impact in the future on client portfolios or composites. All expressions of opinion reflect the judgment of the firm on this date and are subject to change. Included information has been obtained from sources considered reliable, but we do not guarantee that the foregoing materials are accurate or complete. Investors should contact Ulland Investment Advisors for individualized information prior to deciding to participate in any portfolio or making any investment decision. Ulland Investment Advisors does not provide tax advice. All investors are strongly urged to consult with their tax advisors regarding any potential investment.

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