Updated: Nov 9, 2021
A number of investors and analysts have increasingly wondered if inflation might begin to accelerate because of the money the Federal Reserve has folded into the economy and the new stance it is taking on inflation.
At the annual conference in Jackson Hole, Wyoming, Federal Reserve chairman Jerome
Powell announced the central bank would no longer treat inflation as the primary threat to economic growth and would allow more inflation in the coming years before taking action to reduce it.
For years the Federal Reserve has sought to keep inflation at or around 2% and that is where inflation has been for the last decade. This strategy goes back to the belief that nothing is more destructive than rampant inflation, causing the Fed to raise interest rates whenever
it feared the economy might be growing too fast.
Despite its success in keeping inflation on target, the policy of the Central Bank policy is shifting. And the Fed acknowledges the counterintuitive aspect of this shift. It knows higher inflation means higher prices for food, gas, and housing and that means added pressure for families struggling with lost jobs and income during the pandemic. But in the Jackson Hole
Speech, Powell explained that if inflation is too low, it can create expectations of longer-term
inflation being even lower still, and the fear is not so much about higher prices as the negative effect on interest rates. They want to avoid a spiral where lower inflation creates a self-perpetuating cycle.
The Fed explained changes to the price-stability side of their mandate. In the long run the goal is still to keep the inflation rate of 2 percent. However, there is recognition that if inflation runs under 2 percent during and after periods of economic downturns and never moves above 2 percent during strong economic times, then, inflation averages less than 2 percent. And it doesn’t take long for households and businesses to expect this result, meaning that inflation expectations move below its goal and pull the real average for inflation down. So, the Fed wants to see inflation increase in a strong economy to balance times it is lower in a bad economy.
Will they succeed in this targeting for inflation? That’s hard to know. But what’s concerning is that they might succeed at creating lots of inflation. There are a number of reasons for this.
Right now money is pouring into bonds and cash in such a way that suggests many people do not take the threat of inflation remotely seriously. The whole world is awash in liquidity because the Fed and other Central Banks around the world have undergone policies of printing massive amounts of money. From Quantitative Easing during the Great Recession to the recent (and future) stimulus, this money chases goods and services. Oil prices have been low because COVID-19 has kept people home. During the pandemic oil has been around $40 a barrel and few oil companies invest with oil below $50 a barrel. But as life begins to return to normal, supply will spike, and the question is whether supply can keep up with demand.
Oil prices could double from where they are now. And oil price affects our purchasing power because it increases shipping costs, costs of the production of goods, and transportation.
The stock markets have hit all-time highs – and that even during the pandemic. A booming stock market increases wealth and expands purchasing power. And many believe there is room for the markets to continue to increase, especially since interest rates are low and are expected to remain that way.
Stocks have become the preferred allocation because few other asset classes can make the same returns, leading to the TINA effect (There Is No Alternative). Housing prices have reached record levels because of low interest rates and low mortgage rates. And as millennials continue to transition to living on their own, a whole new generation will increase demand for housing. Again, even in the midst of the pandemic, the housing market is booming both with sales and existing home prices. For the first time, the median home price in the United States is more than $320,000.
All these factors suggest we could be heading for higher inflation. Inflation eats up cash savings and reduces purchasing power. Is your portfolio protected against this possibility? At Brixton Capital Wealth Advisors, we are happy to talk with you about ways to protect your portfolio.