After a solid first seven months of 2023, investment markets retreated in August and September after the US Federal Reserve Bank’s July 26 meeting. The Fed Board voted to raise interest rates by 0.25% and has now raised the Fed Funds rate 11 times since March 2022, from 0.0%-0.25% to 5.25%-5.5%. In response, the interest rate on 10-year US Treasuries jumped from under 4% in late July to 4.8% in early October.
Economists have been predicting a US recession since the Fed began raising rates to fight inflation, but US economic growth has not been slowed. Will the current high interest rates be enough to slow US employment growth and curb consumer spending to reduce inflation to the Fed’s 2% target?
While third quarter US GDP growth may appear healthy, there are warning signs that an economic recession will be hard to avoid. US consumers have been resilient, but higher borrowing costs have started to reduce their confidence. High mortgage rates have slowed housing transactions in much of the country. Outstanding credit card debt has surpassed $1 trillion for the first time and the average interest rate is now over 20%. Inflation has been cut in half from 8% to 4% over the past 12 months, but the recent increase in energy costs may keep inflation elevated.
Government pandemic aid is no longer supporting at-risk consumers, but government debt continues to climb. For the fiscal year ending 9/30/2023, the budget deficit was about $1.7 trillion, up more than $350 billion from fiscal year 2022. That brings total US federal government debt to more than $33 trillion. This increased debt, combined with higher interest rates, have driven the interest payments on our government debt higher by 82% in two years (from $352B in FY2021 to $640B in FY2023). At some point interest rates will have to fall so we can afford to continue to pay the interest on our debt without cutting critical government programs.
Rising interest rates have played havoc on expected investment returns over the past three years. While the S&P 500 Index has gained an average of 10.1% per year, the Barclays Aggregate Bond Index has lost 5% per year for the last 3 years. Investors who turned conservative in 2020 when the pandemic hit have been punished by rising interest rates. Aggressive investors who maintained a high allocation to stocks have seen their portfolios grow significantly in comparison. The conventional wisdom that you should increase your allocation to bonds to reduce risk has not worked out recently as a result of the Fed’s actions to control inflation.
The Federal Reserve Board has indicated that they may raise the Fed Funds rate one more time and then hold rates steady until inflation moves closer to their 2% target. This is an indication that we are close to peak interest rates for this cycle. Corporate earnings have declined slightly over the past 12-18 months as the economy has struggled to regain stability since the pandemic. However, it looks like corporate earnings for Q4 are poised to grow, which could boost returns for stocks as we head into year-end.
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This article was authored by Christopher Borden, a financial advisor and Managing Partner located at Canby Financial Advisors, 161 Worcester Road, Framingham, MA 01701. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 508.598.1082 or cborden@canbyfinancial.com.
Disclosure: Certain sections of this commentary contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. Investments are subject to risk, including the loss of principal. Because investment return and principal value fluctuate, shares may be worth more or less than their original value. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. This material is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product.
The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks.The Barclays U.S. Aggregate Bond Index (the “Index”) is a broad measure of the U.S. investment-grade fixed-income securities market.
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