Persistent Inflation: Time to Worry?

If you have been reading the news, you have probably noticed that inflation has been a top headliner. Questions and concerns are rising – when will inflation drop, and when will the Fed cut interest rates, if at all? As the months creep by and we still have not reached the 2% inflation target, fears of stagflation are rising. So, what is going on? 

From COVID-19 factory shutdowns to excessive money printing, inflation today has a variety of causes that originate back to 2020. Whatever the exact order of events that caused it, the U.S. has been battling rates that are far from beneficial to the economy. In 2022, the inflation rate spiked to 9.1%. Then through the Fed’s rapid monetary tightening policies, it dropped to 4.1% in 2023. The current annualized rate is 3%. However, 2% is still the Fed’s target for inflation, as it is the ideal level for economic growth. Levels beyond 2% could pose a threat to consumers by making necessities less affordable. 

What about the Fed’s next move regarding interest rates? Typically, the Fed raises interest rates (“tightening”) in an effort to slow economic growth, which usually lowers inflation. Through higher interest rates, the goal is to compress consumer demand, thereby lowering overall inflation. But inflation is proving to be stickier than expected, causing the Fed to pause in making changes to monetary policy. The result is an environment of inflation and high interest rates, which puts pressure on consumers’ purchasing power.

If the Fed waits too long to cut rates, a recession could occur. On the flip side, lowering rates too soon could trigger rapidly increased spending, rocketing inflation up again. 

With this information in mind, what is wrong with the Fed selecting “wait and see?” There is a growing fear among some of stagflation – the unlikely combination of slowing economic growth and rising inflation. Glancing at today’s metrics, stagflation appears possible. Inflation is creeping down ever so slowly, meaning high prices are here to stay – at least for now – and the economy seems to be slowing down. At the end of 2023, the gross domestic product report showed the economy growing at an annualized rate of 3.4%, while in the first quarter of 2024, the numbers read 1.6%.

Persistent inflation and decreasing economic growth can be worrisome indeed. But, it is worth noting that the downtick in GDP is one data point, and not necessarily indicative of a trend. The saying goes that although history never repeats itself, it often rhymes. In that vein, examining the 1970s period of stagflation might help ease today’s fears. Q4 of 1974 reported an annualized GDP growth rate of negative 1.9%. This number is almost twice as bad as our current GDP – and, notably, it dips into the negatives. In the same quarter in 1974, inflation clocked in at 10.1%. In comparison, the inflation from the end of 2023 to the beginning of 2024 ranks much lower, measured at just 4%.

Unemployment itself is also a good measure of economic distress. In the 1970s, unemployment reached 7.1%, while today’s unemployment is nearly half that, at 4%. So, while stagflation in the 1970s has some economic similarities to today, there are perhaps even more differences.

What will happen then if the Fed does not cut rates, and the economy is left to fix itself? Looking at data from the inflation peak in 2022 to now, inflation is trending downward. While it has reached a sticking point, some experts believe it will continue its downward track to rest at or below 2%. But, as that timeline is uncertain, the Fed is currently “between a rock and a hard place” on the rate-cut decision. If they cut rates too soon, inflation could spike again, but if they cut too late, a recession could occur.

The data, however, suggests inflation rates may slowly return to normal on their own, without a recession. Inflation measured at 7% in 2021, 6.5% in  2022 and 3.4% in 2023. Most recently, the consumer price index dropped down 0.1% from this May, meaning consumer prices are increasing at  the lowest annual rate since 2021. This dropdown also affected the current annual inflation rate, lowering it from 3.3% to 3%. These datapoints increase the likelihood that the Fed will lower interest rates in the near future, with the financial markets pricing in two rate cuts.

Times of unpredictable monetary policies can cause increased anxiety among investors. Possible inflection points in the market outlook combined with uncertain monetary policy is a great time to make sure your asset allocation is aligned with your financial goals.

Steve Kim offers securities and investment advisory services through Gradient Securities, LLC. Member FINRA/SIPC. Gradient Securities, LLC offers investment advisory services under the d.b.a. of Gradient Wealth Management. Gradient Securities, LLC, and its advisers do not render tax, legal, or accounting advice. Brady Associates Asset Management is not affiliated with Gradient Securities, LLC.

Original Article: https://www.ledgertranscript.com/Steve-Kim-Business-Quarterly-56035229