Is Recent Inflation Indicative of an Upcoming Recession?

Weekly Note
Written By Jonathan M. Elliott, CPWA®, CRPC®, CDFA®, ChSNC®, CPFA™, RMA®

There is little relief in sight on the inflation front. March's Consumer and Producer Price Indexes jumped 8.5% and 11.2% year over year. Rising prices for food and energy commodities were primarily behind the cost surge.

The stubbornly high inflation brings more-hawkish monetary policy comments from Federal Reserve leaders. The consensus is that the central bank will hike the benchmark short-term interest rate by 50 basis points at next month's Federal Open Market Committee (FOMC) meeting, which may be the first of a few half-percentage-point increases this year.

Recent commentary has also raised the odds that the Federal Reserve Bank will begin to reduce its balance sheet aggressively, perhaps as early as the May FOMC meeting. Such a reduction–selling bond holdings or allowing them to mature–would remove excess liquidity from the financial system, contributing to inflation. Its asset holdings swelled to nearly $9 trillion following the massive stimulus programs implemented to support the U.S. economy during the height of the COVID-19 pandemic.

Meantime, rising Treasury market yields have caught the attention of Wall Street. The yield on 10-year Treasury notes, used as a proxy for mortgage rates, recently topped the 2.80% mark. That is more than 100 basis points (an entire percentage point) higher than where it sat on March 1st. The resultant higher borrowing costs may ultimately slow the pace of economic expansion.

As 10-Year US Treasury Yield Reaches a 3-Year High

10 Yr US Treasury Yield Chart

An inverted yield curve has been a relatively reliable predictor of a future recession. The early April inversion of the Treasury market yield curve–the yield on the two-year note exceeded that of the longer duration 10-year bond–has raised some red flags about the U.S. economy. The central bank must guard against slowing demand too much, risking "stagflation," a period of high inflation, and slowing economic growth (stagnation), accompanied by rising unemployment. Recession fears may make the Fed's task of stabilizing prices harder, as painfully higher interest rates fight inflation underpinned by supply constraints.

10-Year US Treasury Yield Nears Positive Territory

10-Year US Treasury Yield Nears Positive Territory

Concerns about a more hawkish Fed and falling bond prices are priced into the market. We believe these market conditions call for a portfolio mainly of well-diversified, high-quality equities. A portfolio of mostly high-quality equities serves the investor well to fare the choppy waters of the near-term market.

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Jonathan M. Elliott, CPWA®, CRPC®, CDFA®, ChSNC®, CPFA™, RMA®

I am currently the Managing Partner for our independent investment advisory firm, Optima Capital Management. Together with my business partners, Todd Bendell CFP® and Clinton Steinhoff, we founded Optima Capital in 2019 as a forward-thinking wealth management firm that serves as an investment fiduciary and family office for high-net-worth individuals and families. In addition to being the Chief Compliance Officer, my role at Optima Capital is portfolio management. I have over 22 years of experience in managing investment strategies and portfolios. I specialize in using fundamental and technical analysis to build custom portfolios that utilize individual equities, bonds, and exchange-traded funds (ETFs). I began my financial services career with Merrill Lynch in 2003. At Merrill, I served in the leadership roles of Market Sales Manager and Senior Resident Director for the Scottsdale West Valley Market in Arizona. On Wall Street Magazine recognized me as one of the Top 100 Branch Managers in 2017. I am originally from Saginaw, Michigan, and a marketing graduate from the W.P. Carey School of Business at Arizona State University. I am a Certified Private Wealth Advisor® professional. The CPWA® certification program is an advanced credential created specifically for wealth managers who work with high net worth clients, focusing on the life cycle of wealth: accumulation, preservation, and distribution. In addition, I hold the following designations - Chartered Retirement Planning Counselor (CRPC®), Certified Divorce Financial Analyst (CDFA®), Certified Plan Fiduciary Advisor (CPFA), and Retirement Management Advisor (RMA®). In the community, I am a member of the Central Arizona Estate Planning Council (CAEPC) and serve as an alumni advisor and mentor to student organizations at Arizona State University. My interests include traveling, outdoors, fitness, leadership, entrepreneurship, minimalism, and computer science.

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