Chart of the Week

Last week, the Federal Reserve (Fed) raised the federal funds rate by 0.25%, taking the upper end of the range to 5%. The Fed now faces a trickier task — not only continuing to calibrate between elevated inflation (top chart) and diminishing economic growth, but also ensuring that an abrupt tightening of financial and credit conditions does not push the economy into a deeper-than-expected slowdown.

Away from the attention of rate hikes, some market participants have been concerned about the rapid decline in monetary supply¹ (bottom chart) over the past 10 months. The argument essentially boils down to the view that the Fed has been targeting the wrong issue (wage growth) and using an inadequate tool (rate hikes). They argue that, instead, the Fed should be focusing on growing monetary supply.

Since monetary policy affects the broader economy with long and variable lags, it becomes even more important to manage interest-rate and liquidity risk in portfolios. We reiterate our preference for government securities — particularly U.S. Treasuries — as well as municipal bonds, as they have tended to be more resilient than other sectors when the economy slows or when financial risks are elevated.

¹ Monetary supply as measured by M2, an aggregate measure of U.S. money stock that includes currency, savings deposits, small time deposits, and shares in retail money market funds. For a more detailed explanation please refer to the disclosures section of this report.

Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates. High yield (junk) bonds have lower credit ratings and are subject to greater risk of default and greater principal risk. Although Treasuries are considered free from credit risk they are subject to other types of risks. These risks include interest rate risk, which may cause the underlying value of the bond to fluctuate. Municipal bonds offer interest payments exempt from federal taxes, and potentially state and local income taxes. Municipal bonds are subject to credit risk and potentially the Alternative Minimum Tax (AMT). Quality varies widely depending on the specific issuer. Municipal securities are also subject to legislative and regulatory risk which is the risk that a change in the tax code could affect the value of taxable or tax-exempt interest income. U.S. government securities are backed by the full faith and credit of the federal government as to payment of principal and interest. Unlike U.S. government securities, agency securities carry the implicit guarantee of the U.S. government but are not direct obligations. Payment of principal and interest is solely the obligation of the issuer. If sold prior to maturity, both types of debt securities are subject to market risk.

An index is unmanaged and not available for direct investment.

Consumer Price Index (CPI) produces monthly data on changes in the prices paid by urban consumers for a representative basket of goods and services.

M2 Index measures the money supply that includes cash, checking deposits, and other types of deposits that are readily convertible to cash such as CDs.

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