Our goal is to keep you update with the markets and what is going on in our economy. In light of everything that happened last week, here are some thoughts from Chief Economist, Brian Wesbury with First Trust Portfolio:
While many investors are focused on the financial troubles affecting Silicon Valley Bank (SVB) and whether those troubles will spread, there were two other major issues that hit the markets last week: the Biden budget and Fed Chief Powell hinting at raising rates by a half a percentage point rather than a quarter.
It shouldn’t be any wonder why investors are worried about the Biden budget proposal, which includes a murderer’s row of growth-destroying tax hikes. The top tax rate on capital gains and dividends would go to 44.6% versus a current 23.8% (almost double!), the top tax rate on regular income would go to 44.0%. Taxes would go up on S Corporations, small business income, and interest income. The corporate tax rate would jump to 28%; the stock buyback tax would go to 4% versus 1%.
If this proposal were passed by Congress, it would hammer the economy and the stock market. Thankfully, we believe the odds of these proposals making it into law are very slim to none.
Think about it. Nothing was stopping President Biden from making these proposals last year or the year before. Why didn’t he? Because he knew some in his own party would object, making them impossible to pass and undermining party unity. But now that Republicans control the House the Administration can pursue extreme tax hikes secure in the knowledge the plan won’t pass (and cause economic damage) while the House majority party takes the lead opposing the proposals.
As for the prospects of the Federal Reserve raising rates by half a percentage point next week, we think Powell would only open the door to that possibility if it were his intention to go through that door. However, the news about SVB, news that Powell didn’t have before his testimony last week, now makes a 50 basis point hike unlikely.
The bottom line is that in spite of investors and markets obsessing about rate hikes they need to focus on the money supply. The supply of money exploded in 2020-21 but peaked in early 2022 and has since declined at the fastest pace since the 1930s. It’s the growth in the money supply, or continued lack thereof, that will determine what happens to economic growth and inflation in the next couple of years. Obsessing about the short-term interest rates targeted by the Fed, when there is no real market for federal funds traded among banks anymore, is barking up the wrong monetary tree.
Financial markets are on tenterhooks right now. But SVB is not a systematically important bank that will, through counter-party risk, tear down the whole financial system. Instead, it’s symptomatically important, showing what happens when the Fed ignores Milton Friedman and the money supply and then claims inflation is transient when it isn’t. SVB’s managers made a huge mistake by not hedging its assets’ interest-rate risk. But it's a mistake they were seduced into making by bad monetary policy that was too loose for too long.
As always we will continue to monitor the economy and markets. Please don't hesitate to reach out with any questions.