I certainly wish we had the “all clear” signal on the extreme inflation of the past two and half years, and with this week’s lower than expected inflation report there does seem to be some hope along these lines. Unfortunately, however, there are a couple remaining inflationary forces that may not be willing to let go just yet, namely the housing market, the job market and of course the poorly managed federal government.
When it comes to the inflation topic, I do think the Federal Reserve may deserve a tad bit of kudos. While the Fed was surely culpable for igniting the problem in the first place with its massive increase in money supply during COVID, and too low for too long interest rate policy, after a slow response out of the gate addressing the problem it helped create, the central bank has shown a measured policy resolve over the past 18 months.
To be sure, rapidly raising the Fed Funds rate from effectively zero percent in December 2021 to 5% today can only be considered intrepid by any standard, and despite this week’s lower than expected 0.2% increase in the CPI (a primary inflation metric) most Fed watchers continue to expect another 0.25% rate hike or two before it's over. This pace has been the fastest interest rates have ever been hiked in the history of the Fed, and is likely a large part of the reason inflation is cooling off.
If the Fed policy changes could be afforded a little time to continue cooling the pace of borrowing, it's reasonable to believe we may see inflation continue to cool, and maybe even get a little persistent disinflation in some of the prices in stuff that got really out of hand like eggs, milk and used cars. But, alas, the Fed does not operate in a vacuum and we have complications.
The first complication is in the housing market. The U.S. simply does not have enough homes in the country to meet housing demand. Ordinarily newly forming families and people seeking to obtain or change housing can be accommodated by new supply from home builders and the resale market. During COVID, however, the large home builders learned how to optimize their operations and have adopted a “just in time” construction process which meets demand as it comes. This innovation has been a boon for the home builders, but has also led to very little impulsive supply and no price negotiation power on behalf of buyers. Which means home prices continue to remain stubbornly strong.
How about buying existing homes? Forget about it, as all of us who gobbled up sub 3% mortgages during the pandemic are in no mood to let go of these great rates and finance another house at current mortgage rates around 7%, there just aren’t enough existing homes on the market. The home supply issue has no easy solve, and in a way, by keeping rates too low for too long the Fed is now being forced to eat their own cooking as the problem it created is now providing an unanticipated tail wind to inflation.
Then of course we have the job market. I for one detest discussion of the Fed seeking to loosen the job market to relieve wage pressures, as no one deserves to lose their job as a result of economic policy changes. At this time, however, there simply continues to not be enough workers to meet demand. And it is not just the coffee shops and restaurants that are starved for help, try hiring an accountant or engineer in today’s job market. The people just aren’t out there, and so the wage scale continues to move higher as well, certainly contributing to overall inflation. Once again, not an easy or quick problem to solve, and regardless of how high the Fed sets interest rates, it can’t create more workers.
Finally, we have our federal government. Remember all those politically contentious, massive spending bills the Biden administration engineered toward the end of the pandemic? You know, the American Rescue Plan ($1.9 trillion), the Infrastructure and Investment Act ($1 trillion), and the CHIPS bill ($52 billion)? Well, we know the government never does anything quickly or efficiently and much of this capital is just now starting to hit the street, not to mention the leftover COVID programs such as the Employment Tax Refund Credit we hear about constantly on the radio, which is in the process of mailing decent size checks to businesses of all sizes across the country.
So, just when the Federal Reserve is trying to sop up the huge increase in money supply it created, the federal government is busy pumping trillions out the back door. You really can’t make this stuff up.
This week’s inflation report was encouraging and I wish I could say I thought we were in the clear, but I think we have a bit more road ahead of us with this inflation thing. Plan and invest accordingly.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stock investing includes risks, including fluctuating prices and loss of principal. No investment strategy can guarantee a profit or preserve against loss. Past performance is not a guarantee of future results. This material may contain forward looking statements; there are no guarantees that these outcomes will come to pass.
Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at marc.ruiz@oakpartners.com. Securities offered through LPL Financial, member FINRA/SIPC.