Big changes shaking Wall Street hide an inconvenient truth: It’s a return to normality | Business

NEW YORK – It’s easy to get carried away with all the superlatives about investing and financial markets.

The yield on 10-year government bonds is at its highest level since 2007! The Federal Reserve has raised its key interest rate to its highest level since 2001! Pension funds are facing one of their worst years in decades!

All the hubbub neglects the fact that financial market conditions are actually returning to historical norms, not deviating from them.

Certainly the speed at which interest rates have risen since the spring is staggering. But the 10-year yield is still lower than it has been for about three decades, from the late 1960s to the late 1990s.

Rather than viewing today’s conditions as strange, it may be easier to think of the last few decades as an anomaly. Since breaking the specter of high inflation in the 1980s, the Federal Reserve has been quick to help the economy and financial markets through tough times.

This meant that the Fed could cut interest rates to zero if there were large numbers of layoffs or the stock market fell too sharply. As if that weren’t enough, the Fed could continue with unconventional programs, such as buying as many bonds as it deemed necessary to keep financial conditions favorable. The Fed was able to do all of this because inflation simply wasn’t a problem for a long, long time.

It is now. and that means the Federal Reserve doesn’t have the same freedom to cut interest rates as quickly because lower interest rates can fuel inflation more.

After decades in which changes like the Internet and offshoring of production helped reduce inflation, the global economy now faces conditions that could worsen it. For example, companies want multiple suppliers, not just the cheapest ones, after the pandemic revealed how difficult supply chains are.

“We believe higher interest rates will continue as the Fed pursues tight policy to combat inflation,” BlackRock Investment Institute strategists wrote in a recent report.

What this all means for investors depends on what type of investments they are making.

For savers looking for safe places to put their money, the much higher returns offered by online savings accounts, CDs and short-term Treasury bills are welcome. Instead of getting almost nothing, they finally get something.

There is both a plus and a minus for investors who hold longer-term bonds. Higher yields mean new bonds issued today will produce more income. That’s helpful. But older bonds pay less. This causes their prices to fall, hurting investors who already hold bonds in their portfolios.

This can make the situation significantly more difficult for equity investors. When bonds pay higher interest rates, investors are less willing to pay high prices for stocks, which are riskier and can force investors to wait a long time for big growth. This puts downward pressure on all stocks.

“That hurts even more when the stock market looks expensive overall relative to corporate earnings, and it adds pressure to be selective,” said Bryant VanCronkhite, senior portfolio manager at Allspring Global Investments. A return of inflationary pressures means economic cycles may not last as long as they once did, VanCronkhite says.

“The Fed was very good at manipulating the economy and markets because they could focus on full employment and let the market cycle run longer,” he said. “If the country is ill-equipped under this new paradigm or unwilling to establish itself in the markets at the same speed, it is natural that we will see slightly longer and more frequent recessions than before.”

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