By Tim Courtney, Chief Investment Officer
While investors faced supply chain disruptions, labor shortages, a war and increasing odds of a recession, inflation and interest rates remain the primary movers of markets. On Wednesday, Consumer Price Index (CPI) data revealed inflation rates hit 9.1% in June.1 The Federal Reserve, like a doctor using medicine to break a fever, is trying to use higher rates to break inflation, but so far, to no avail. Inflation has accelerated nearly every month going back to September 2021.2
This is making markets fear rates will need to be raised higher and higher, just as former Fed chair Paul Volcker did in the early 1980s to break 1970s inflation. As rates went higher, financial assets like stocks and bonds had to be revalued lower, and the economy tipped into recession. While there are some similarities to that time, (there is a fear of recession and the dollar is strengthening today just as it did in the early 80s) there are also similarities to the late 1940s and early 1950s.
That time followed the very large government spending of WWII and the reopening of the full economy with pent up demand. During that period, interest rates also rose, but stayed below the rate of inflation for many years, helping the government pay back relatively large debts. That could happen again today, but now interest rates are not the only tool that can be used to fight inflation. There are some causes of inflation (supply chains, labor shortages, regulations) on which interest rates will have little effect. Other tools will likely be employed in order to fully tame inflation.3
Money supply. Over the last few years, the federal government significantly increased fiscal spending, flowing funds through unemployment benefits, stimulus checks and Paycheck Protection Program (PPP) loans.4 The Fed also provided monetary stimulus by purchasing trillions in bonds, ETFs and mortgages, though some thought this surpassed their authority.5 From 2020 to 2021, the M2 measure of money supply grew nearly 40%, well above the usual 5-6% annual increase.6 Although the last several readings suggest the money supply has peaked and may be flattening out, the large amounts of money flowing through the economy almost certainly pushed inflation higher. This will likely need to be reduced to help lower inflation.
The workforce. The Bureau of Labor & Statistics reported employers added 372,000 jobs to the workforce in June, keeping the unemployment rate at 3.6% for the fourth straight month.7 While this report exceeded expectations, businesses across the country remain decorated with hiring signs and staffing shortage messages. The latest Gross Domestic Product (GDP) report suggests productivity has increased, barely, but it is unclear if this is coming from people working more productively or working harder in understaffed conditions.8 The country is going to have to encourage more people to work as the employment rate is still below that of 2019.
The market desperately wants to see inflation peak and begin to come down. Interest rates will help, but they alone cannot solve the problem. As always, if you have any questions, please contact your Exencial advisor.
- The U.S. Bureau of Labor Statistics (7/13/22) — Consumer price index – June 2022
- Trading Economics — United States inflation rate
- Org (06/2002) – A Rehabilitation of Monetary Policy in the 1950s
- USAspending (5/31/22) — The federal response to COVID-19
- Reuters (4/29/20) — Fed support fuels corporate debt spree in April
- St Louis Fed (6/30/2022) – M2 Money Supply
- The U.S. Bureau of Labor Statistics (7/8/22) —The employment situation — June 2022
- The U.S. Bureau of Economic Analysis (6/29/22) — Gross domestic product (third estimate), GDP by industry, and corporate profits (revised), first quarter 2022
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