Regardless of your political views or beliefs on monetary policy, one thing is clear... In general, people appear to have increased assets due in part to stimulus checks and increased wages. As a result, inflation has run wild and is at its highest rate in over four decades. Last week, the Labor Department released its January report indicating a CPI (consumer’s price index) of 7.5%. What does this mean for consumers and how may it affect your budget and purchasing power moving forward?
Inflation is a measure of the increase in broad prices, or a decrease in the value of money given a constant level of goods and services. Why does inflation occur? Economic theory tells us that as the demand for goods or services rises above production, or level of supply, a rise in prices will occur. However, just because the price of used vehicles increases does not necessarily mean the price of everything else will follow suit. For example, if you were to strip food and energy from the latest CPI report mentioned above, inflation (in terms of CPI) was only 6% in January. Additionally, depending on lifestyle and spending habits, people will experience inflation at varying levels. But why are we experiencing it right now?
There’s no argument that COVID-19 and its partners in crime, Delta and Omicron, have negatively affected the supply of goods and services across the broad economy. Increased sickness resulting in staffing shortages as well as the great resignation among millions of employees are among the top reasons why we are seeing record high inflation numbers. Further, consider how interdependent the world economy has become. We purchase iPhones manufactured in China, coffee produced in Brazil, and clothes knitted in Vietnam. Combine a global pandemic, an over expansion of money supply, and geopolitical factors, and inflation results. Keep these factors in mind as we transition to the investor’s perspective and how the Federal Reserve is trying to correct the supply and demand issue we are witnessing today.
Over the past 10 years, interest rates have been at a record low. This has made financing large purchases (i.e. a car or home) much easier and has enticed people to spend money than they otherwise would if rates were higher. The Fed is now trying to curb inflation by raising the cost of borrowing. Ideally, this has a trickledown effect on consumers who witness higher prices, like we are seeing, and allows the supply of goods and services to balance out demand. Now with inflation running its course and the Federal Reserve raising interest rates, the ability for firms to make capital expenditures to fuel continued growth is being hindered. Infant and growing businesses need to borrow a considerable amount, and a rise in interest rates makes becoming profitable that much more difficult. Though the market has shown incredible resilience given the global events of the past 24 months, stock prices may see volatile days ahead as analysts and investors alike respond to Fed rate hikes. Can market growth continue for the next 24 months? The level of demand does not appear to be slowing any time soon and the supply of goods and services, in general, appears to be catching its counterpart. Federal Reserve, the ball is in your hand.