- Fed presidents mostly see slower 2H21 growth but no recession.
- Inflationary spikes are viewed as transitory.
- The IEF will likely head modestly lower.
When I analyze an ETF that tracks the treasury market, I first look at inflation along with the Fed's latest interest rate policy announcement and economic projections. I recently wrote a piece on the TLT that contains that data. Here, I'll delve a little bit deeper into what several Fed Governors are thinking about inflation and the economy.
Investment thesis: the NASDAQ:IEF's primary purpose is to lower portfolio volatility. Use a sliding scale: the more conservative you are, the larger your position should be of this ETF.
Chicago Fed President Charles Evans isn't concerned about inflationary pressures since inflation expectations are contained:
This brings me to a very important factor in the inflation outlook, especially for 2023 and 2024. The lesson of the inflation of the ’70s and ’80s—and articulated so well earlier by Milton Friedman and Edmund Phelps—is that to generate higher inflation in the long run, you have to generate higher long-run inflation expectations. We are not seeing that today. Importantly, in my view, the current surge in relative prices due to supply factors is not leaving a worrisome imprint on long-run inflation expectations.
Here are the supporting charts:
5-year inflation expectations (which are derived by subtracting the 5-year TIPs yield from the 5-year treasury bond) started to increase at the end of the last recession. They peaked a few months ago just above 2.5% and have been trending sideways since.
10-year inflation expectations (10-year treasury minus the 10-year TIPS) follow the same pattern except they are slightly below 2.5%.
Atlanta Fed President Bostic sees a full recovery (emphasis added):
"There is a lot of shuffle and a lot of jumble and a lot of turbulence" as people juggle family responsibilities with a return to work, companies turn to automation amid labor shortages, and the coronavirus crisis continues, Bostic said in comments to the Mid-Size Bank Coalition of America. "But at the end of the day the trajectory of the economy is solid. My models and the data I am seeing suggest we are on firm footing towards a full recovery and momentum is going to continue strong even amidst the rise of Delta."
Cleveland President Harker sees a slower 4Q21 but no recession (emphasis added):
In recent months, the Delta variant has led to a sharp increase in new cases, particularly among the unvaccinated. Hospitalizations and deaths have not risen to the levels seen earlier in the pandemic because of the efficacy of the vaccines, but these developments have dampened consumer sentiment and have led to a downturn in some activities that require close physical contact. So far, the adverse effects on consumer demand appear to be smaller than those seen in earlier waves of the virus. It appears that as vaccination rates have risen, households and businesses have learned to better navigate changes in virus conditions. I expect that the monthly indicators and pace of activity will continue to ebb and flow with virus developments. The Delta variant will temper consumer spending and growth over the second half of the year, compared to the first half, but I don’t expect it to lead to widespread shutdowns of economic activity or to derail the recovery. Nonetheless, continued increases in vaccination rates and the deployment of safe and effective vaccines to children would contribute significantly to lowering risks and broadening the recovery.
On balance, I expect growth to be less robust over the second half of this year, compared to the first, but for the year as a whole, growth will be strong, at around 5-1/2 percent, which is well above trend. Next year, I anticipate that the headwinds from supply constraints will begin to ease and the recovery will broaden. Growth is likely to remain above trend but at a more moderate pace of 3-3/4 to 4 percent, as the tailwinds coming from the pandemic-related fiscal support and pent-up demand fade.
Finally, New York President Williams also sees slower growth in the second half of the year (emphasis added):
So, to continue with the news analogy, here’s the lede: I expect gross domestic product, or GDP, to increase around 5 ½ to 6 percent this year. My current forecast accounts for strong growth in the first half of 2021, but also balances some slowing of growth in the remainder of the year relative to the first half.
He also sees the current inflationary spike as transitory (emphasis added):
We saw some very high monthly inflation readings in the second quarter of this year, reflecting pandemic-related supply bottlenecks and imbalances, but more recent data have shown that the inflation rate is moderating. The earlier spike in inflation largely reflects the effects of the rapid reopening of the economy, which pushed supply and demand in extreme ways. In fact, we are now seeing some of the pandemic-related spikes retrace, including prices for lumber, used vehicles, and rental cars. This process of adjustment may take another year or so to complete as the pandemic-related swings in supply and demand gradually recede. As the economy gets through these highly unusual dynamics, I expect inflation to come back down to around 2 percent next year.
Overall, Fed presidents are largely on the same page about the economy. There will be a second-half slowdown, but overall growth this year will be strong. The supply-chain issues which are causing inflationary pressures will dissipate (Fed President Evans noted that higher prices will attract new suppliers). All also added a cautionary note about the virus -- that it made forecasting even more difficult.
For our purposes, two IEF charts are relevant.
The IEF's chart parallels that of the TLT. Prices have recently broken the trendline of a Sping rally and are heading modestly lower.
In August, prices consolidated in a triangle pattern. They broke through support during the last few weeks and are now below the 200-day EMA.
The classic no-fuss portfolio is 60/40 stocks/bonds. Bonds provide income and lower volatility. That's still their primary purpose for individual investors. The IEF is currently at 115. A 5% decline would send prices to 109 -- which is below last April's lows. But that would increase the overall yield.
With the Fed on the record with rate hikes, the IEF probably won't be rallying. But it's also not going to fall through the floor. This ETF is all about beta. The more conservative you are, the larger your position should be.
This article was written by
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