On the heels of stronger inflation expectations, The Federal Reserve opened the door to begin tapering its bond purchasing program and signaled interest rates will need to rise sooner and faster. Markets reacted to the news with major stock indexes closing lower and bond yields moving higher.

Inflation pressures have continued to build in the U.S. economy (see CPI chart). Consumer prices just last month rose 5% from a year earlier and accelerated at their fastest pace in nearly 13 years. However, Fed officials reiterated many of the factors pushing up inflation are the result of transitory aspects related to the economy reopening, such as raw material shortages and supply chain issues. As supply catches up with demand, policymakers believe short-term price increases should begin to recede.

 

While the liftoff of interest rates was widely publicized, policymakers unanimously left short-term borrowing rates anchored near zero and the eventual Fed-funds hike was penciled in two years from now. More immediate however is the Fed’s anticipated plans to reduce its massive $120 billion monthly asset purchases of Treasuries and mortgage-backed securities. As for the labor markets, the Fed expects improvement in job growth as the economy continues to reopen and temporary factors such as jobless benefits expire.

The Fed showed commitment and flexibility to meet its dual mandate of maximum employment and stable prices. While the committee raised its expectations for inflation and brought forward the time frame on when it will next raise interest rates, the Fed also emphasized the economy has substantial ground to recover before officials begin actively discussing liftoff. At Peloton we take a constructive view on the Federal Reserve’s monetary policy, yet remain mindful of market valuations and volatility. We continue to believe it is prudent to stay the course, re-balance asset allocations, and favor high quality stocks and bonds. Looking forward, the importance of active management will only increase as stronger balance sheet companies will provide attractive investment opportunities for patient investors.

Disclosures

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