A Tricky Recipe

You’ve probably noticed the volatility wreaking havoc in the markets over the past few weeks. To understand what’s going on, let us tell you a story.

Imagine you are inside a fancy restaurant, waiting for your meal to be prepared. While you wait, you can watch the chefs as they work. Suddenly, though, you notice there seems to be some uncertainty going on in the kitchen. By listening closely, you can just barely make out what the chefs are arguing about: Does the recipe call for two teaspoons of salt, or two tablespoons? Or is it even two cups?

One by one, the other diners start paying attention to the debate, too. Each voices their opinion to the other. Some diners want the chefs to add two teaspoons of salt. They rationalize that, while you can always add more salt later, but you can’t ever un-salt your food. Too much salt will ruin both the meal and everyone’s night. Others point out that there are no salt shakers on the tables, meaning if more salt is needed, the chefs will have to do it themselves. That will delay the meal, and people need to eat now. Better to just use two tablespoons. Sure, maybe the food will end up a little too salty, but that’s better than overly bland food — or no food at all.

As the wait drags on, the diners start getting nervous. They decide to amend their order and ask for less food. Other diners decide to leave the restaurant entirely. Finally, the head chef announces the restaurant is committed to adding just the right amount of salt, so they will add it gradually, little by little, until they know they have it right.

Unfortunately, this little speech, while providing clarity as to the chef’s intentions, does nothing to quell the concerns of all the diners. Some applaud loudly, others boo. Some rush to order more food, while others ask for the check. Before long, the noise is deafening.

Maybe, you think, we should have just ordered a pizza.

Crazy as it may seem, this little play actually describes some of what’s going on in the markets right now. (Except that the chefs are the Federal Reserve, the food is the economy, the recipe is for bringing down inflation, and the salt is interest rates.)

For the last nine months, the Federal Reserve has been trying to follow an incredibly tricky recipe: Bring down inflation without bringing down the economy. Just as chefs use salt to flavor food, our nation’s central bank uses interest rates to help moderate runaway consumer prices. The problem both face is it can be difficult to know how much of that magical ingredient to use. Just as too much salt can make food unbearable to eat, raising interest rates too high, too fast can trigger a recession. Raising interest rates too little, however, might do nothing to quell inflation. And like those diners in the story who needed to eat, consumers need relief from inflation now.

Those diners, of course, are investors. Every investor has their own opinion on what the Fed should do. More importantly, every investor is trying to guess what the Fed will do. That guessing is the prime reason for all this volatility. Investors who believe rising interest rates will hurt corporate earnings and trigger a recession decide to eat somewhere else, bringing the stock market down. Investors who still see the restaurant as the best place in town – regardless of interest rates – order more food and drive the markets back up.

Remember in the story how the head chef came out and made a big speech? Well, that’s my attempt at describing what Fed Chairman Jerome Powell did two weeks ago. Every year, Powell delivers a speech in Jackson Hole, Wyoming where he reveals the Fed’s views on the economy. In the days leading up to his speech, some investors thought he might announce the Fed would look to dial back on hiking rates much further. Their reasoning? Some data suggests inflation is peaking, so there’s no need to keep raising interest rates.

Powell wasted no time in dashing those hopes, however. In his speech, Powell said that this is “no place to stop or pause.”¹ Fighting inflation will remain the Fed’s number one priority for the foreseeable future. That means the Fed will continue to gradually raise interest rates, likely around 0.5% to 0.75% every few months. He further said:

“While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.” ¹

In other words, bringing down inflation is simply more important than stimulating economic growth right now. (Or propping up the markets.)

This is why there’s been so much volatility in the markets lately. It’s also why we can expect volatility to continue, at least in the short-term. Many economists expect the Fed to hike rates by another 0.75% later this month. So, don’t be surprised to see more volatility before and after that announcement, if it comes.

The reason we’re telling you all this is to assure you that, while volatility is never fun, it is not unexpected. It has not taken us unawares. Nor, frankly, do we feel it’s something you need to stress over. You see, here at Minich MacGregor Wealth Management, we act more like “financial dietitians” than anything else. (This is the last food metaphor, we promise.) A dietitian focuses on using the fundamentals of good nutrition to help people eat better, healthier foods so they can achieve their health goals – regardless of what’s “in style” or what celebrity fad-diet is trending. As your financial advisors, our job is to help you achieve your financial goals, in part by making sound, long-term decisions, not overreacting to what the Fed does – or says – or what the market thinks about it.

To put it simply, the volatility we’ve seen lately is the same old story we’ve been reading about all year long. It’s the same story we’ll probably continue to read about moving forward. For that reason, our advice is to enjoy the end of summer rather than stressing about market headlines. Our team will continue to monitor your portfolio. And of course, if you ever have any questions or concerns, please let us know. That’s what we’re here for!

¹ “Powell warns of ‘some pain’ ahead as the Fed fights to bring down inflation,” CNBC, August 26, 2022.  https://www.cnbc.com/2022/08/26/powell-warns-of-some-pain-ahead-as-fed-fights-to-lower-inflation.html