Why rates keep rising

Market Update

NOV 19, 2022

I'm not married to any single theory when it comes to understanding what the market does. I'm not always bullish, not always bearish - I believe in looking at the changing market conditions and adjusting my sails. Over the course of the last several months, the FED has raised interest rates multiple times. Unless you've lived under a rock, you've probably seen a few of the headlines and have heard from both real estate agents and buyers/sellers about how hard it's been to buy/sell a home.

I've written about this before, and I'll reiterate, The FED's responsibility is only twofold: stable (1) prices and (2) employment. Prices are determined by the supply and demand of goods. Market demand is determined primarily by consumer's income levels (employment), we'll start there.

Over the the last couple of years, wage and job growth has been strong and unwavering, almost as a big middle finger to the dip we experienced when the world descended into chaotic standstill. Wages have been growing about 10% YOY and total non-farm payroll data indicates 200k+ jobs added in the economy just last month. To elaborate in whole numbers - there are 10,000,000+ job openings and only 6,000,000 unemployed workers. I'm not sure how else to put this: Consumer demand is ferociously increasing with a vengeance. It's to be expected: the FED dumped more than $2 Trillion into the economy to keep it afloat through COVID.

To breakdown and understand the effect that's had on prices (and inflation), you have to understand the basics of market price equilibrium (P). P is the price consumers are willing to pay for a good, based on the intersection of their demand (D) and market supply (S). If D jumps, but S falls or remains, P increases.

At equilibrium price P, Supply = Demand

Here's a simplified example: if there are only 5 oranges available for sale, and 10 people want oranges, the price of oranges will go up until 5 people decide they can't afford it anymore. Due to the surge in demand, coupled with the reshuffling of global labor forces due to COVID, supply chains have been struggling to keep up pace.

This brings us back to what the FED's responsibilities are: stable prices and employment. Employment is strong and so the FED will focus on reducing price inflation - and it will do so at any cost. Interest rate hikes are meant to discourage people from borrowing money, in a bid to pull money out of the economy and curb demand. It sounds absurd to think that your government wants to prevent you from buying things and spending, but it's doing so to prevent milk costing $100/gallon in a couple of years.

The $2T question of when the FED might stop their quantitative tightening? I have no idea.

My theory is that as long as job numbers are strong, it gives the FED confidence to continuously raise rates in an attempt to curb inflation. If we start to see job growth fall, unemployment rise, and inflation cool down - that would be my indication that we've reached some sort of a market bottom.


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