Inflation figures through the most recent reporting period ended November 2021, saw the Consumer Price Index (CPI) for All-Items rise 6.8% over the past twelve months. According to the BLS, this is the largest 12-month increase since 1982. Inflation readings for Energy rose 33.1% and Food rose 6.1%. Both are the largest 12-month increases in at least 12 years.
The big question is, will this inflation be permanent or is it a temporary, or, transitory change? In recent communications, Jay Powell and the Federal Reserve have revised Fed policies away from a transitory view and are now looking to tighten monetary policy sooner than originally planned.
The Fed’s first announced change is to reduce their monthly bond purchases more rapidly. Bond purchasing by the Fed, or quantitative easing, provides liquidity to the bond market, drives bond rates lower, and helps cash starved corporations raise money in the bond market.
As the Fed reduces and eventually stops their bond buying activity, the bond market will have to rely solely on private sources of funding. Theoretically, bond rates should rise as Fed support wains.
After the Fed stops buying bonds, they will be considering raising the Fed Funds lending rate. As bond yields and interest rates rise, corporations face higher financing costs. This cost increase begins to slow borrowing activity, causing economic activity to slow. The Fed’s desired outcome is to lower inflation by slowing economic activity.
Higher energy costs work as a natural economic activity dampener. Businesses use energy to manufacture & transport good and to provide certain services. Households use energy to heat and cool homes and for transportation. Businesses are often able to pass on higher input costs to consumers in the form of higher prices. Households on the other hand must pay higher prices on the goods and services they need in addition to higher energy costs for their own use.
Academic economics teaches that as prices rise, consumers will substitute down to keep spending level. For example, when the price of steak rises, consumers will substitute ground beef for steak. Energy costs cannot be substituted. Many households work on a limited budget and as more and more budget is absorbed by higher energy costs, spending on other items decreases.
This decrease in spending slows the economy. In some situations, slower spending leads to recession. When the economy slips into recession, corporate and household spending declines even further. Lower spending is ultimately deflationary for energy prices and many other items measured by the CPI.
In conclusion, it is important to monitor inflation, interest rates, monetary policy and fiscal policy and their combined impact on economic activity. The economy appears to be gliding along smoothly today, however, the boom/bust economic cycle is still a reality investors must be cognizant of.
That is at least part of the reason we believe it is important to pursue the guidance of a professional Investment Adviser. Registered Investment Adviser firms like Schmitt Wealth Advisers, and employees who are registered Investment Advisers Representatives have a fiduciary obligation to put you and your family first. We help clients plan for retirement, manage money, identify risks, and seek ways to help mitigate risks that may negatively impact their financial future.
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