Inflation becomes a problem.
One of the main questions on investors’ minds thus far in 2022 is, how did inflation become such a problem? Prior to 2022, both the federal government and the Federal Reserve had been stimulating the economy in an extreme way. This was in the form of forgivable PPP loans, enhanced unemployment benefits, and multiple rounds of COVID checks from politicians in Washington D.C. Central bankers also stimulated with ultra-low interest rates as well as trillions of dollars of bond purchases. This excess stimulus contributed to increased demand for goods and services at a time when global supply chain disruptions led to limited supply. When combined with the energy supply disruptions that are a byproduct of the Russia-Ukraine conflict, significant levels of inflation are now present for the first time in 40 years.
How bad is inflation?
Domestic inflation was moderate in the years following the great recession from 2009 through 2020. During the 12-year time period, annual inflation averaged just 1.8%. In the middle part of 2021, inflation began to pick up and by year-end, prices had increased 7.0% in calendar year 2021. The pace has accelerated in 2022 with inflation running between 8.0% - 9.0% for much of the year. To put this in perspective, we have not seen 8.0% inflation since the early 1980s. As a side note, for those of us who do not use energy or buy food, consumer prices excluding food and energy have increased a more modest 6.6% over the past 12 months.
Reduced monetary stimulus.
With inflation rising so rapidly, the Federal Reserve is now in a position where it needs to reduce stimulus quickly. To accomplish this, the Federal Reserve has increased interest rates five times thus far in 2022. First by 0.25% in March, followed by 0.50% in May, 0.75% in June, 0.75% in July, and another 0.75% in September. Bringing short-term interest rates from near 0% in January to just over 3% now. As a result, those looking to borrow money to purchase a car, or house, or expand their business will be paying significantly more in interest to access funds. For example, 30-year mortgage rates have increased from 2.88% to 6.66% in just 12 months. To put that in perspective, with the median home price at $440,000, that would increase a new monthly mortgage payment from $1,827 to $2,828. That is an extra thousand dollars every month for 30 years!
The Federal Reserve has been able to increase interest rates so rapidly because the labor market has been quite strong. In addition to an extremely low unemployment rate of 3.5%, there are over 10 million unfilled positions in the U.S. right now. With only 5.8 million individuals unemployed, that is nearly two job openings for every single job seeker. In addition, the total number of working individuals reached a new all-time high in September. At 158.9 million workers, the current level of employment now exceeds the previous high set in February 2020, just before the COVID pandemic turned the economy upside down.
Falling asset prices.
To bring us full circle, excess stimulus, plus supply disruptions, plus war in Ukraine have all contributed to dreadful levels of inflation. The high inflation has led to monetary tightening (i.e., the Federal Reserve increasing interest rates while also reducing its balance sheet), which in turn has produced falling asset prices. With the exception of commodities, which can benefit from higher inflation levels, year-to-date investment returns are negative across the board. With broad indices for taxable bonds, global stocks, and real estate down 13.5%, 25.6%, and 29.4% respectively, investors are certainly feeling the pain of a rising interest rate environment.
This publication contains general information that is not suitable for everyone. All material presented is compiled from sources believed to be reliable. Accuracy, however, cannot be guaranteed. Further, the information contained herein should not be construed as personalized investment advice. There is no guarantee that the views and opinions expressed in this publication will come to pass. Past performance may not be indicative of future results. All investments contain risk and may lose value. © Oct. 2022 JSG
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