Lexicon Financial Group Weekly Update

Monday, November 8, 2021

 

Upcoming Event

Last week, a policy announcement was made in the United States by the FOMC -- the Federal Open Market Commission – to leave overnight interest rates unchanged. The FOMC is part of the Federal Reserve (“The Fed”). The Federal Reserve also announced that it will begin tapering its bond purchases starting later in November.

As with so many of these announcements, the markets largely anticipated this move, and North American equity markets climbed higher. For the period between November 1 and November 4, the TSX/S&P gained 0.59% while the S&P500 gained 1.44%. (1)


Looking In

We’ve recently heard from clients who want us to dig a little deeper and explain how capital markets interconnect and fit together. Given that the news of the week was dominated by the FOMC announcement, I thought it would be interesting to look at what the Fed actually does and how decisions made impact capital markets.

The role of the Fed has evolved since its founding in 1913. Originally, it was a response to bank collapses that occurred in the 19th and early 20th centuries as a means to provide stability to the system. Imagine going to your local bank and finding out that they could not give you your money. It’s like a scene out of “It’s a Wonderful Life”. Creating the Fed helped address money shortages, allowed banks access to credit, and built confidence in the overall system.

The FOMC – Federal Open Market Commission – meets approximately eight times a year to vote on policy in response to ongoing and changing market conditions. Their goals are to stabilize prices and maximize employment in the United States. Of course, this juggling act isn’t easy. More jobs equates to more money in the economy, which drives prices higher. Higher prices is a tell-tale sign of inflation - the cost of goods and services rising over time. Indeed, many central banks around the world have a goal of holding annual inflation to between 1-3%, annually. In the US, inflation was measured at a 13-year high of 5.4% in September 2021. So what could the FOMC do from a policy perspective to reduce inflation?

In general, there is an inverse relationship between inflation and interest rates. If interest rates are low, economic expansion occurs and inflation increases. That’s because consumers have more money to spend – the cost of servicing existing debts is lower. The pandemic has changed things. At the onset of the pandemic, interest rates were already at historic lows. There was nowhere for the Fed to cut, so instead they stimulated the economy by buying assets themselves. Last week they announced that they would be tapering – gradually reducing – the amount of these purchases. This easing of purchases should – one assumes – have a similar effect to a rising interest rate. In the fight against inflation, removing economic stimulus is the textbook response. This move will put upward pressure on interest rates, which should put downward pressure on inflation.

 

Looking Out

Of course, we will continue to keep a close watch on inflation. Earlier last week I spoke with Amy Steciuk, Portfolio Manager with Cougar Global Investments. Each month the investment team at Cougar Global completes a comprehensive macro-economic scenario analysis, reviewing risks and opportunities for investment in the global economy. Amy shared that in the last 12 months the risk of inflation has become more important to how their investment portfolios are constructed.

It’s amazing how much can change in a year.

Further Reading

 

The opinions expressed are those of Craig Swistun and not necessarily those of Raymond James Investment Counsel which is a subsidiary of Raymond James Ltd. Statistics and factual data and other information presented are from sources believed to be reliable but their accuracy cannot be guaranteed. It is furnished on the basis and understanding that Raymond James is to be under no liability whatsoever in respect thereof. It is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of securities. Raymond James advisors are not tax advisors and we recommend that clients seek independent advice from a professional advisor on tax-related matters.

  1. Data provided by Factset showing the price return of S&P500 and TSX for November 1 -November 4, 2021 in its respective local currency.

 

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