Mind on Money: Proper response to inflation is crucial

Mind on Money: Proper response to inflation is crucial

The expectation of “transitory” inflation itself proved, unfortunately, transitory. Over the past two weeks we’ve learned the Federal Reserve indicated it is no longer using this expectation in its economic planning and policy going forward.

While the results of this expectation shift may have some challenging implications for investors, in the grand scheme this sea change is likely a good thing.

The COVID-19 crisis has been nothing short of devastating to many lives, from the illness itself, the loss of loved ones, the emotional tolls of isolation, and in no small way the social upheaval and division it has exasperated among Americans.

Through aggressive policy action from both the federal government and the Federal Reserve, the United States does appear to have economically weathered the COVID storm. Stock markets remain near all-time highs, economic growth is recovering quickly, and unemployment remains near historical lows.

While we are not without our challenges, such as supply chain disruption and decelerating job growth, our economy appears resilient currently.

What was the price of this resiliency? Money, lots and lots of money. The federal government has flooded the economy with a series of huge relief packages valued at $4.5 trillion (source: usaspending.gov) and the Federal Reserve has expanded the money supply by $5.5 trillion since the start of the crisis in early 2020 (source: Wall Street Journal).

This $10 trillion injection of money into the economy and markets is completely unparalleled in the history of modern economics, and perhaps the most basic law of economics is that more money means higher prices. Like unsupervised cake at a kid’s birthday party, the results have been predictable. The economy is wired, everything with a value seems wound up, and as any parents with a back seat full of wired post-birthday party toddlers knows, there may be a cost to pay later.

Well, later is likely coming soon. The Fed acknowledging that the inflation being experienced is not transitory is the first step in this process. The central bank has already prepped investors to prepare for a reduction in the $120 billion it is injecting into financial markets every month, and prior guidance indicated this tapering of new money injections would be wrapped up by June. There are now some voices within the Fed that would like to see this timetable accelerated (source: Bloomberg).

Economically this is welcome news to me. It’s been a long time since Americans have dealt with the type of inflation being experienced right now and is possible going forward if aggressive monetary economic continues. While the headline inflation rate of 6.2% last month is concerning in its own right, anyone who has purchased anything of material value over the past six months has experienced that this number doesn’t do the reality on-the-ground justice. Prices on main street are rising, and rising very quickly.

Studying other inflationary periods in history reveals, once inflation is unleashed on an economy, it is not easily reined in. By recognizing the potential economic risks of recent price increases and acting more swiftly to adjust the policies contributing to the trend, the Fed may just save us from more pain down the road.

This doesn’t mean, however, the process will be painless. The Fed’s primary mechanism of injecting money into the financial markets occurs with bonds, and the $120 billion being infused each month has obscured the bond market from developing true pricing for many bonds. As this new money support is withdrawn, there is bound to be pricing adjustments and corrections, and where the dust will settle is impossible to predict.

As I’ve said before, when the bond market sneezes the stock market catches the flu. 2021 has been a fairly easy year to be an investor, as we enter the post-pandemic economic phase in 2022 it will be very important to not be caught complacent.

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. 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.