School’s Out for Summer

Beyond the academic and social benefits, school provides something else of immense value to families: structure and a predictable routine. During the school year, my family knows what time we need to be out the door in the morning, there is a set rotation of classes during the day, and a consistent dismissal time each afternoon. This clarity allows our family to form realistic expectations, and to find a sense of security and stability within these routines. As we transition to summer, that structure evaporates rapidly.

The summer months, while evoking thoughts of travel and sunshine, also bring feelings of stress for many families that have to navigate new routines and camp schedules once the structure of school disappears. When clearly defined patterns are removed, both kids and their parents feel untethered.

A similar transition is unfolding in the stock market as the Federal Reserve evaluates its next steps. For over a year, the Fed has communicated a clear trajectory to investors. They have remained hyper-focused on reducing inflation, and more importantly, they provided clear guidance about raising rates ahead of each of the past ten Fed meetings.1 Now we are entering a new phase in which the Fed is sending a signal of flexibility rather than definite, continued action. This shift is leaving investors feeling uncertain about what the next few months will hold, much like parents when that final school bell rings before summer break.

The Fed’s Forward Guidance

Over the past 20 years, the Federal Reserve has increased the transparency and frequency of its communications with the public, including more frequent forward guidance in describing its monetary policy decisions. At the end of each Fed meeting, they announce rate decisions and share forward guidance – which the Fed defines as any “official FOMC communication that is intended to signal to the public the likely future path of monetary policy.”2 Investors then parse every word in an attempt to glean additional insights about future policy decisions which leads market prices to adjust as economic expectations shift.

The Fed is holding their June meeting next week, and will announce their decision on raising rates again or holding them steady. Futures markets show that investors have high confidence that they will hold rates steady, marking a break from the 15-month rate hiking cycle. Coupled with Congress’ resolution of the debt ceiling uncertainty, this expected “pause” has provided a significant tailwind for markets in recent weeks. Investors envision a reprieve from the pressure of higher rates, and interpret this as a signal that the fight against inflation may finally be reaching a plateau. 

Pause Doesn’t Mean Pivot

Looking ahead to the next Fed meeting in July, traders are split on what the next step will be, with futures markets implying a 35% chance of a continued pause and a 65% chance of at least one quarter-point hike.3 These expectations will shift after the Fed provides an update to their forward guidance next week and as other economic data points emerge, potentially sending mixed signals. We expect that they’ll choose their words carefully and keep as much flexibility as possible since inflation continues to run above their target levels.

While the odds look good for the Fed to pause their pattern of rate hikes, some investors may be getting overly optimistic that the Fed’s overall policy will pivot to a new direction. This optimism comes on the heels of other positive developments in the market – President Biden signed Congress’ debt-ceiling legislation last week, the early-2023 US banking industry turmoil seems to have stabilized, and the most recent monthly jobs report showed a resilient and robust labor market. This is good news for the economy and corporate earnings, but it also means that investors can’t rule out a July rate hike even if the Fed decides to take a wait-and-see approach in June.

A general sense of calm nevertheless continues to flow over markets, with the CBOE Volatility Index (VIX) maintaining its downward trend this week. The VIX, or “fear Index,” has fallen by -20% over the past month and has reached 13.65.That’s the lowest level since February 14, 2020. Put another way, investors are the most relaxed they’ve been since before the start of the Covid-19 pandemic.

In the midst of the current market environment, we continue to rebalance portfolios. This allows us to systematically take some of the gains that have accumulated within stock funds, since the summer months ahead may lack the clear direction that we saw in the first half of the year. The dual risk of persistent inflation and deteriorating corporate earnings will influence the Fed’s ability to pivot, and we will not be surprised to see further rate increases from the Fed in future months.

Good Portfolios are Timeless

The beauty of a long-term outlook is that short-term events rarely change the direction we are heading. Whether it is a big unknown like the debt ceiling, a disruption like the failure of a regional bank, or just the regular ebb and flow of quarterly corporate earnings, our portfolios are designed to be resilient across the full economic cycle. Deliberate diversification, regular rebalancing, and a long-term outlook are the foundation of our investment approach for clients.

As we move into summer, we recommend ignoring the short-term noise of Fed meetings and interest rates, even if the next few months bring a return of volatility in equity markets. Opt instead to embrace new routines, longer summer days, and a break from the school year, knowing that your portfolio will remain resilient through any ups and downs the coming months may bring.

Resources

1 Federal Funds Rate History 1990 to 2023 Forbes

2 Forward Guidance as a Monetary Policy Tool. US Federal Reserve

3 A Fed Pause Now Looks Likely. But Don’t Mistake It for a Pivot. Barrons

Brian Kozel, CFP 

About Brian Kozel, CFP®

Brian is a partner, senior advisor, and Chief Investment Officer at North Berkeley Wealth Management. Brian helps clients feel confident as they navigate their financial journey.

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This commentary on this website reflects the personal opinions, viewpoints, and analyses of the North Berkeley Wealth Management (“North Berkeley”) employees providing such comments, and should not be regarded as a description of advisory services provided by North Berkeley or performance returns of any North Berkeley client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data, or any recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. North Berkeley manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

By |2023-07-21T15:10:22-07:00June 9th, 2023|