Break-even math: How much gain is needed to recover from a loss fully?
Investors may undervalue the impact of investment losses and don’t know that more significant gains are needed to recover fully.
Federal Reserve Chairman Jerome Powell said explicitly in his semiannual congressional testimony that he supports a 25 basis point rate hike at the FOMC meeting in two weeks and expects that “a series” of further increases will be necessary over the remainder of the year. He again stressed the robustness in the labor market and repeated that the Fed would tighten more aggressively should inflation fail to dissipate as expected.
At the same time, he sounded a cautionary note on the war in Europe, calling the conflict a “game changer” and saying that the effects could last for years. Russia is relatively insular and its direct ties to the U.S. are modest — prior to the pandemic, it was the 40th largest export market for U.S. goods — but the potential meltdown of the world’s 11th largest economy will not come without consequences. If nothing else, the threat of contagion effects, especially in the financial markets, should give the Fed pause as it removes accommodation in the months ahead.
In 1998, in fact, the Fed backed off tightening plans and delivered three rapid rate cuts in response to a global credit crunch that had started innocuously enough one year earlier with a devaluation of the Thai baht. There are obviously major differences between the two events, but the point is that global developments can evolve in unpredictable ways and that policymakers can respond to them even if they have limited impacts on the domestic economy (as the Fed was easing in the late 1990s, real GDP was growing well in excess of 4.0 percent and the jobless rate had already fallen below most prevailing estimates of full employment; not coincidentally, however, the S&P 500 had at the same time slumped into a deep correction). The confidence interval for Fed policy this year was already relatively wide given the uncertainties surrounding the pandemic; in just the last week, it has gapped out further.
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NFM-18677AO.1