After experiencing the shortest recession in modern history during February and March of 2020, the Federal Reserve unleashed a massive amount of stimulus measures along with Congress passing the Cares Act. Both proved successful to restore confidence in the market and economy.
Stocks came roaring back after an almost 34% selloff in the S&P 500 in less than six weeks. Both the economy and the stock market continued to rally in 2021 with the United States continuing to lead the way. The U.S. bond market measured by the U.S. Barclays Aggregate Bond Index finished in negative territory, down 1.54%, for 2021 in anticipation of more aggressive Fed policy in 2022.
The Federal Reserve announced they would begin reducing their monthly bond purchases in November 2021 with expectations for them to complete the purchasing in March of 2022 — setting the stage for the Federal Reserve to begin raising rates as early as March 2022.
Expectations are for the Federal Reserve to raise interest rates four times this year; however, the Fed has indicated that they will be flexible and focusing on the data throughout the year and are not on a pre-set schedule.
The Federal Reserve will be paying close attention to inflation, employment, and economic growth throughout the year as they determine the path of future rate hikes. We expect inflation to continue to be elevated this year due to an increase in housing/rents, food and beverage, and wage pressures, which all tend to be more persistent. However, we would expect many of the less persistent inflation measures to begin to come down as supply chains improve throughout the year.
Expectations are for inflation to come down from elevated levels especially in the second half of 2022, but remain well above the Fed’s 2% target.
We expect increased volatility in both the stock and bond market in 2022 due to a more aggressive Fed policy, less government stimulus, inflation remaining elevated, and many geopolitical risks. More aggressive Fed policy can weigh on both stock and bond prices as worries of a Fed policy mistake take hold.
The Fed has a difficult path ahead to reduce stimulus in the market while trying to reduce inflation, all the while being mindful of not being overly aggressive to cause the economy to contract.
Historically, stocks work well as an inflation hedge as long as the Fed does not adopt an overly aggressive policy approach. The bond markets tend to struggle — especially longer-term bonds — as interest rates increase, which weigh on bond prices. However, it is rare for the bond market to have back-to-back negative return years. The economy is expected to grow at a healthy pace in 2022, with both company earnings and consumer spending leading the way.
Keith Bonjour, CFP, is vice president and portfolio manager for Northwest Bank & Trust Company Investment Management Group, Davenport.