Exercising caution is always a good idea for investors nearing or in retirement. That advice is particularly applicable today, as some riskier assets are pulling back in May.
Prudent investors may also want to heed some recent commentary from the Federal Reserve.
“The Federal Reserve’s latest Financial Stability Report warned of the risks associated with elevated asset values, noting that a decline in risk appetite could lead to broader stress in the financial system,” according to Nationwide Economics. “This is an obvious tautology, but it highlights that, for all the recent focus on transitory inflation and augmented measures of employment, the Fed is still very much attuned to asset prices and will adjust its policy trajectory as necessary should market movements alter the macro outlook. And, of course, this reaction function is highly asymmetric; the Fed has in recent decades been quick to ease (or at least temper its tightening plans) when risk assets have faltered but has been slow to pursue restrictive policies in frothier environments.”
Another element for investors to consider today is that in bygone eras of rising inflation when equities pulled back, the Fed boosted benchmark lending rates.
“Benchmark interest rates were often lifted during market pullbacks in the 1970s and 1980s when inflation concerns were predominant, but the spotlight on wealth effects in the 1990s and systemic risks in the wake of the Global Financial Crisis has given rise to a de facto braking mechanism within and in advance of monetary tightening cycles,” adds Nationwide. “The taper tantrum of eight years ago is a prime example.”
For now, Fed Chair Jerome Powell appears committed to not considering rate hikes until 2023. However, a rapid rise in inflation could force a change of that tune.
“It would come as little surprise should similar market ripples slow the transition into the next tightening cycle, as well. The markets may not be garnering the lion’s share of the central bank’s attention at the moment, but they are a good bet to be front and center when they eventually take a marked turn for the worse,” concludes Nationwide.
For more on income strategies, visit our Retirement Income Channel.