Stocks rebounded after the March 2020 pandemic recession. When the world shutdown economic activity (everything but essential businesses), the potential fallout sent the stock market in a swift downturn. On March 9, 2020 the Dow fell 7.79%; on March 12, it fell 9.99%; and then on March 16, it fell 12.9%. Three of the worst drops for the index in U.S. history. By March 2021, the markets rebounded 79% from lows made in 2020.
The Federal Reserve and stimulus saved the day. The government provided three rounds of stimulus including $850 billion of direct payments to taxpayers. The Federal Reserve kept rates at zero and purchased $6 trillion in assets. Between the two, it helped the U.S. economy survive and then thrive once the economy began opening.
The U.S. shutdowns are in the rearview and the Fed is looking to fight inflation and return interest rates to a more normal level. According to Fed Governor Lael Brainard, the Fed plans a “rapid” reduction in its balance sheet. This means the tremendous stimulus present since the pandemic is ending. A metaphor that many use is the Fed is removing the punch bowl from the party. The Fed raised interest rates for the first time since 2018 this month and indicated another six rate hikes in this year.
How does rising interest rates affect economic activity? Lower rates lead to expansion as borrowing is less expensive and the opposite is true when rates are rising. A good example is the increase in 30-year mortgage rates, which, as I write this, are averaging 5.176%. As of Jan. 31, 2022, the rate on a 30-year mortgage averaged 3.625%. This makes buying the same home now as compared to two months ago more expensive. As borrowing gets more expensive, it tends to slow economic growth.
Another fear from the Fed tightening is a recession. The Fed embarked on a series of interest rate increases nine times since 1961 to fight inflation and eight out of those nine times, a recession followed. The Fed funds rate controls short-term interest rates, which doesn’t necessarily mean long-term rates will follow. This leads to the dreaded ‘inverted yield curve.’ An inverted yield curve is where short-term interest rates are higher than longer term rates, which has predicted a recession within 1-2 years since 1955, except for one false signal.
Since the pandemic, issues with the supply chain constrained economic activity. Many countries continue to shut down in response to COVID. Before the pandemic, just-in-time inventory was the norm. This worked well in a global, fully open world economy. When demand stopped and manufacturing, traveling and trade halted because of the pandemic in 2020, supply dried up. When economies reopened, demand rebounded immediately without a boost to supply. Disruptions were everywhere, with shortages in carriers, manufacturers shutting down, etc. When high demand meets low supply, inflation follows (demand-pull inflation).
The big wild card is Russia’s invasion of Ukraine. While the human toll is incalculable, the conflict has many economic impacts. The first, most obvious impact was on the gas pump. Russia produces 12% of the world’s oil. European nations are the largest buyer of Russian oil and Russia supplies 40% of Europe’s gas needs. Australia, Britain, Canada and the U.S. currently have bans on importing Russian oil. The EU is split on whether to sanction energy imports from Russia, with Germany opposing. The economic sanctions on Russia in response to Putin’s unprovoked war have set Russia’s economy back by 40 years.
With the threat of recession, a war disrupting commodity supplies, labor shortages and tightening monetary policy, the markets are showing an expected level of volatility. Given the dire news, the S&P 500 is only down -4.57% year-to-date ending April 4, 2022.
Judy Loy is Registered Investment Advisor, ChFC®, RICP® and CEO of Nestlerode & Loy, Inc.
All investing is subject to risk, including possible loss of the money you invest. Nothing in this article should be construed as investment or retirement advice. Always consult with a professional advisor and consider your risk tolerance and time to invest when making investment decisions. Review your personal situation with a professional before planning any gifting or estate planning.
