01. “Meeting by Meeting”

From Bennett Fees, Economic Research Associate

To little surprise, the Fed enacted another quarter-point hike bringing the target range of the Federal Funds Rate to 5-1/4 to 5-1/2 percent. In different terms, the Fed has increased interest rates by a whopping 525 basis points since March 2022. The trouble is the countless ways you can evaluate the effects and success of these hikes. On a yearly basis, headline PCE rose 3.8% and Core PCE which excludes the food and energy categories rose 4.6%. Broadly speaking, Powell is focused on core inflation, even though there are more tailored measures used behind the scenes. Indeed, as discussed last week, measures of PCE inflation can vary widely.

What’s important is Powell’s outlook on the trajectory of future monetary policy. Predictably, Powell is hesitant given only moderate easing in the labor market. The best example of this is that despite the level of interest rates, unemployment has remained at the same level since the beginning of the tightening. This forces Powell to look elsewhere. In his words:

“The labor force participation rate has moved up since last year, particularly for individuals aged 25 to 54 years. Nominal wage growth has shown some signs of easing, and job vacancies have declined so far this year. While the jobs-to-workers gap has narrowed, labor demand still substantially exceeds the supply of available workers.”

Arguably the most important dynamic of these is the “jobs-to-workers gap”. While there are more intricate ways of mapping this out, here is a simple visualization.

The idea is that the high level of job openings relative to people looking for work is a historical inversion that may put upward pressure on wages and correspondingly inflation. Even though it will be another eight weeks before the FOMC meeting, there is plenty of data (and the famous Jackson Hole Symposium) in the meantime. Most immediately, employment data will arrive next Friday so stick around for a deeper dive into the labor market situation and its effects on monetary policy.

02. Bending the rules, rich person style

From Nate Hoskin, Founder & Lead Advisor

The catch is this thing called the Pro-Rata Rule and if you already have a Traditional IRA or a Rollover IRA, doing a backdoor Roth might make that money taxable twice. That’s because transfers out of a Traditional IRA are taxed proportionally to the whole balance, which includes every IRA you have, not just the little part you want to be rolled over.

I’ll give an example but first, you should know you can also do this with a 401k and it’s called a Mega Backdoor Roth because you can save $66,000 into your Roth. Let me know if you want me to explain that next week!

Let’s say you have $10,000 in a Traditional IRA that you haven’t paid any taxes on yet. If you contribute $6,500 after tax that you’re planning to roll into a Roth, you’ll have to pay taxes again because you can’t just pull out the same $6,500.

The pro-rata rule calculates the taxable portion of that transfer based on all money in your Traditional IRAs. With $10,000 pre-tax and $6,500 after-tax, 40% will be tax-free but the other 60% will be taxable again as if you were taking out a chunk of the original $10,000. So if you already have money in a traditional IRA, a backdoor Roth might be off the table, unless you roll that money over instead (which is an extra tax bill).

You can also roll Traditional IRAs into your 401(k), which does not count toward the pro-rata rule, if you want to make backdoor Roths possible.

03. What is bad debt?

From Jon Scott, Lead Author

Debt isn’t all bad. There is good debt and bad debt. For example, mortgaging a piece of land (making monthly payments to pay off the land and own it in full) is an example of good debt. Buying a brand-new luxury car is bad debt. So how do you determine good debt versus bad debt?

A simple philosophy is if your debt is likely to yield more income than the debt you are paying off. For example, an education. Let’s say you attend your local state university and graduate with a degree in engineering. You have some student debt, but the income you will receive thanks to being employed as an engineer far outweigh the cost of going to school.

An example of bad debt is the aforementioned new luxury car. Nearly all cars depreciate as soon as you drive them off the lot (though COVID supply shortages changed things for a bit), while you are saddled by debt to payoff of the car. Even if you bought the car in cash, you will likely have to make repairs at some point.

More examples of Bad Debt:

• Cars - By the time you leave the car lot, the car will have already depreciated in value. As mentioned above, cars are a necessity for a lot of us, but that still doesn’t categorize this asset under good debt.

• Clothes - Similar to cars, clothing’s value plummets as soon as it’s purchased... Of course, clothes are necessary for all of us, but, if you need to go into debt to buy a certain pair of sneakers, it probably isn’t a good idea.

• Consumables - Many things can fit into this category, but the general idea is the same. If it depreciates in value, going into debt to purchase something is a bad idea.