Federal Reserve Chairman Jerome Powell is accused of being “behind the curve” on inflation. Let’s take a look at what that criticism means. The Fed is tasked with keeping employment full, prices stable, and inflation low. This balancing act is often achieved through monetary policy and money supply: when interest rates are low, money is easy and people buy lots of “stuff”. As time goes by and people buy more stuff, prices might start creeping up (inflation). By raising interest rates and tightening up the supply of money, the Fed tempers the buying and inflation stays in check.
Trying to catch the runaway car
When inflation is on the move and accelerating, it is much like a runaway car. To slow or stop that car, one must accelerate ahead of it, then gradually slow down and slow that runaway car. For Powell to be behind the curve implies he is well behind the runaway car that is inflation. Critics mainly blame Powell for this. He identified the runaway car early, but thought it would slow down on its own. It hasn’t, and now those same critics believe he (the Fed) is behind the curve.
The best tool the Fed has for slowing down inflation is to raise interest rates. Jerome Powell has signaled that we will have 3 or 4 interest rate increases this year. (The market currently expects a baseline of 4 hikes in 2022). The Fed has also indicated that it will be a less aggressive bond buyer this year, effectively letting bond prices drift down and interest rates drift up.
Areas of the bond market we like
We remain fans of the 5-10 year part of the curve for bond purchases. The risk/reward seems out of whack for 25-30 year bond purchases because prices on those bonds could fall 17-20% this year if rates move up even 1%. On the other hand, a 7 year bond would be looking at perhaps a 5% fall in price on a 1% increase in yields.
In addition to traditional bonds for the fixed income portion of the portfolio, we also like preferred stocks. VRP (a variable rate preferred ETF) and PFXF (a fixed rate preferred ETF) are paying roughly 3.70% and 4.90% respectively and remain two of our favorite additions to the fixed income portfolios.
It is too early in the year to tell if Powell is truly behind the curve, but by mid year, we should have a good sense of where things are.