The Fed Tightening Cycle

Market Update
Written By Jonathan M. Elliott, CPWA®, CRPC®, CDFA®, ChSNC®, CPFA™, RMA®
The Fed Tightening Cycle

Photo Credit: Katie Moum

The Fed’s Favorite Tools: Low-Interest Rates and Monthly Asset Purchases

The Fed is holding interest rates near 0% and expects to keep rates there through 2023. In addition, the Fed is purchasing $80 billion in US Treasuries and $40 billion in Mortgage-Backed Securities (MBS) each month. Recent Fedspeak has laid the groundwork to keep monetary policy accommodative for an extended period of time. Following the April Fed meeting, Chairman Jay Powell said the Fed wants to see “substantial further progress” before changing course. In addition, multiple Fed presidents have called tapering talk “premature.”

Mapping Tightening Cycles Using the Federal Funds Target Rate

Mapping Tightening Cycles Using the Federal Funds Target Rate

The problem with the Fed's view is economic data indicates the economy does not need this level of support. Manufacturing activity, as measured by the ISM Mfg PMI, is robust. Employment is rising as the economy reopens and workers are called back. Housing demand is reaching pre-2008 highs. Pandemic restrictions are being lifted, creating a potential wave of pent-up consumer demand. The stronger the economic recovery grows, the more difficult it is for the Fed to justify purchasing $120 billion each month and holding interest rates near 0% through 2023.

Statistics Across Historical Tightening Cycles

Statistics Across Historical Tightening Cycles

The Fed knows it, and the market knows it. Even Treasury Secretary Yellen, a former Fed official, recently acknowledged that "it may be that interest rates will have to raise somewhat to ensure that our economy does not overheat.”

We expect the months ahead to be full of tapering and tightening talk. In our view, it will be difficult for the Fed to hold off on tightening until 2023. We believe that the Fed will start hinting at tapering in late 3Q21 or 4Q21 and could be forced to tap in late 2021 or early 2022 instead of 2H23. Multiple central banks are already tightening, such as the Bank of Canada's move last month to cut its monthly bond-buying by 25%.

If history is a guide, the market will be a few steps ahead of the Fed.

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Jonathan M. Elliott, CPWA®, CRPC®, CDFA®, ChSNC®, CPFA™, RMA®

I am currently the Managing Partner for our independent investment advisory firm, Optima Capital Management. Together with my business partners, Todd Bendell CFP® and Clinton Steinhoff, we founded Optima Capital in 2019 as a forward-thinking wealth management firm that serves as an investment fiduciary and family office for high-net-worth individuals and families. In addition to being the Chief Compliance Officer, my role at Optima Capital is portfolio management. I have over 18 years of experience in managing investment strategies and portfolios. I specialize in using fundamental and technical analysis to build custom portfolios that utilize individual equities, bonds, and exchange-traded funds (ETFs). I began my financial services career with Merrill Lynch in 2003. At Merrill, I served in the leadership roles of Market Sales Manager and Senior Resident Director for the Scottsdale West Valley Market in Arizona. On Wall Street Magazine recognized me as one of the Top 100 Branch Managers in 2017. I am originally from Saginaw, Michigan, and a marketing graduate from the W.P. Carey School of Business at Arizona State University. I am a Certified Private Wealth Advisor® professional. The CPWA® certification program is an advanced credential created specifically for wealth managers who work with high net worth clients, focusing on the life cycle of wealth: accumulation, preservation, and distribution. In addition, I hold the following designations - Chartered Retirement Planning Counselor (CRPC®), Certified Divorce Financial Analyst (CDFA®), Certified Plan Fiduciary Advisor (CPFA), and Retirement Management Advisor (RMA®). In the community, I am a member of the Central Arizona Estate Planning Council (CAEPC) and serve as an alumni advisor and mentor to student organizations at Arizona State University. My interests include traveling, outdoors, fitness, leadership, entrepreneurship, minimalism, and computer science.

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