It’s definitely been an eventful year. While we typically use this time of year to recap the previous 12 months and offer thoughts on the upcoming year, this time we will focus on the recent economic developments and a recent policy shift by the Federal Reserve as evidenced by the December Federal Open Market Committee (FOMC) meeting.

Summary of the FOMC’s December meeting

Earlier this summer, the FOMC had announced that they were going to begin tapering off their purchases of U.S. treasuries and mortgage-backed securities. These purchases were emergency measures implemented at the onset of the pandemic to buoy the economy from the shock of mandated shutdowns in the name of public health, softening the landing in industries like travel and leisure and others forced to lay off workers due to slowing economic activities.

While the Fed’s announcement about increasing the velocity of the taper was no surprise to most market participants, the release of the Fed’s dot plot did catch some off guard: Fed participants went from predicting zero to one rate hike to a median forecast of three rate hikes in 2022. Many now believe that the FOMC may begin raising rates when the taper is complete. The Fed is now in a position to increase interest rates in 2022 for the first time since December of 2018. The target date to end tapering has moved from June 2022 to March 2022.

What caused the pivot

Some pundits believe the Fed is “behind the eight ball” in moving forward toward a neutral (at the least) monetary policy. One of the main drivers of the policy adjustment has been the persistence of inflation and predictions of near-term inflation and exactly when price increases might slow down. It bears mentioning that inflation is running at the highest level in nearly 40 years. November’s Consumer Price Index (CPI) data (released in December) showed a year over year increase of 6.8%. Prior to the December meeting, the FOMC’s stance was that inflation was transitory and caused by the imbalance of supply keeping up with the onslaught of demand unique to the reopening during a pandemic. Some notable areas where price increases are evident are in goods like used cars and rentable housing. Wages have also risen at a faster pace leading some to believe inflation will likely run at a higher pre-pandemic level. In the statement following the FOMC’s meeting, the word “transitory” was left out.

Bond market reaction to the FOMC’s meeting

At first, bonds had reacted negatively to the news, driving yields up and prices down, but eventually things stabilized. The 10-year U.S. treasury moved above 1.50%, for example, but is back closer to 1.40% at the time of the writing of this article. The bond market had quite a bit of volatility leading up to the FOMC meeting. Things seem to be settling in now at least from the perspective that new information has been digested. At least the writing is on the wall now as to what is expected from a monetary standpoint.

Wildcards

There certainly are a few wildcards to consider as anything could happen. First, the pandemic and market reaction to news about the pandemic are very real. Presently, the equity markets continue to sell off as the new variant of the coronavirus takes hold while the previous variant has not yet been extinguished in many places across the world. There continue to be indications of hospitals being stretched thin, and new and/or prior mandates are being implemented in parts of the U.S., while some countries are shutting down again in order to combat the new variant. Obviously, the pandemic continues to be in focus. Another slowdown or forced shutdown could cause the FOMC to recalibrate.

Additional geopolitical concerns could also cause a policy shift. China and Russia are two world players worth keeping an eye on. Continued tensions between Russia and the Ukraine, along with tensions between Taiwan and the Chinese, will obviously cause strife with each country’s relationship with the U.S. along with the rest of the world. While events might not cause a shift in monetary policy, U.S. treasuries still remain a safe haven for investors globally.

Lastly, 2022 is a midterm election cycle. There likely will be very little movement in fiscal policy that will require congressional action save for one of the above factors or additional factors causing necessary action. I think it is safe to say while we cannot predict the future, we do expect volatility in the markets in 2022.

What should the investor do?

It should be noted that while rates currently remain low, yields in the U.S. remain among the highest in the industrialized world (Singapore and Australia are two areas that have higher yields.). Couple higher rates with the quality of our debt, and U.S. treasuries are an attractive place for global investors to place funds. From a credit union investor perspective, we still believe that timing the market is an extremely difficult thing to do and that a planned-out ladder strategy continues to be most effective for credit union portfolios. Our department has made other suggestions in the past regarding asset selection, and going into 2022, we echo some of those sentiments:

• Invest in assets that might benefit from higher, short-term rates. Floating rate securities fit the bill here.
• If liquidity is a concern, use U.S. treasuries to fill in spots on your ladder. Not only are U.S. treasuries liquid, they have also offered attractive yields versus other non-callable instruments. While CDs aren’t a security, it is good to compare the rates received versus that of U.S. Treasury securities. In the second half of 2020 and most of 2021, the number of financial institutions needed to bring in outside funding (selling CDs) was below the average we had seen in years prior. Institutions that did need to raise funds were able to do so at lower rates, in some cases lower than treasuries. A credit union portfolio with the ability to purchase U.S. treasuries could do so as an alternative or to supplement CD purchases.
• Callable bonds might be another asset class that makes sense when building a portfolio. If we stay on the trajectory of a rising-rate environment, an investor who purchases a callable bond is less likely to have that bond called. At the same time, the issuer of the called bond will have to compensate the investor in the form of higher yield for the investor to “sell the issuer” the call option. If the bond goes to maturity, the investor is going to get a yield higher (and higher return) than bullet securities (U.S. treasuries and Government Agency bullets) and CDs.

These are just three suggestions for asset selection. To discuss your credit union’s unique situation, please reach out directly either to me or to your senior investment services representative at 800/366-2677.

It is likely that until the world moves away from the cloud that is the pandemic, markets will remain volatile. While it might be tempting to just wait for the predicted three rate hikes to invest, there are far too many wild cards and “what if’s” to not stay the course and to stay invested. We will continue to provide info through the market commentary on our website, communication through our investment representatives, and our quarterly economic update webinars. On behalf of Corporate One and our investment department, we wish you and yours a happy and safe holiday season.