The upcoming weeks are developing into an interesting time for the financial markets. While the argument can be made that all things are transitory, the Fed’s definition of transitory has been a few months. Core inflation is at a thirty-year high with no sign of abatement. Inflation appears likely to linger. Many of America’s best companies have commented about the supply chain and labor shortages. Numerous companies are offering several thousand dollars in signing bonuses to entry-level employees just to attract new hires. Other companies are addressing the employee shortage by finding their own logistics solutions to get goods to their customers.
Rising inflation is just not a U.S. issue. As the world recovers from the shock and reopening of COVID, the global supply chain has been broken. Some countries have seen enough of rising prices. The combination of surging demand with easy monetary and fiscal policy has created a massive amount of money in the global financial system.
To combat run-away inflation, some foreign central banks have begun raising short-term interest rates. It is not believed the U.S. is ready to raise interest rates, but the Fed has been signaling its intention of slowing the pace of purchases of bonds and mortgage-backed securities, a measure known as Quantitative Easing. By signaling the market of this intention, the Fed is hopeful the markets will take the news in stride. So far, so good. But there is no doubt that policymakers will be monitoring the markets very closely should the taper become official.
The Biden infrastructure, social welfare, and taxation plan are still not a done deal. Odds are that the plans will be implemented. There has not been enough time to adequately review the policy and how it might affect the U.S. financial and real estate markets. However, as we have opined previously, we don’t like the idea of increased taxes on capital gains on investments, especially if not inflation-adjusted. If taxes are raised too high on speculative investments, the desire to take risks will diminish.
The bond market remains sanguine on inflation but the yield curve has begun to flatten as future rate hikes seem more likely. As a result, slowed economic growth is probable. Remember, the Fed can control the short end of the curve but not the long end of the curve (unless the Fed implements yield curve control). Many banks price corporate bonds off of the 5-year Treasury so as this yield rises, so will corporate interest expense. With mortgage rates drifting higher, loan volume has slowed. This should come as no surprise. Alternative mortgage products are leading the charge for many of Insignia Mortgage’s clients. Many new home buyers and refinance applicants are not bankable with traditional lenders as many applicants have opaque financial structures. This segment of applicants tends to have hard to understand income, be from a foreign country, or are quite substantial from an asset standpoint. Real estate has been a great hedge against inflation historically. The combination of low-interest rates and rising real estate values continue to keep transaction activity high.