March 21, 2022

We Have Liftoff – Finally

Dennis
&
Aaron

This past Wednesday shortly after the conclusion of a regularly scheduled meeting, the Open Market Committee of the Federal Reserve, the body within the Fed that dictates monetary policy, decided to at last raise interest rates.  The move, a 0.25% rate hike, comes exactly two years to the day after the Fed cut rates by 1.00% and launched an historic multi-trillion dollar Quantitative Easing (QE) program, one in which the Fed would purchase bonds thereby injecting liquidity into the economy in an effort to combat the negative economic impact stemming from the then raging pandemic.

 

Before we blame the Fed, the Trump or Biden Administration for the current state of the economy as it pertains to inflation, let’s give the Fed some credit as one week after the Fed cut those100 basis points (each basis point equals 1/100 of a percent) on March 16,2020, the stock market bottomed after having fallen nearly 35% in less than a little over a month and in so doing stabilized the financial markets along with provided the economy with the liquidity to survive the pandemic.

 

Fast forward to today, the Fed is faced with an economy resounding with structural dislocation as a result of too much liquidity having been injected into the economy, the invasion of Ukraine by Russia and an unreliable supply chain(manufacturing, shipping, labor) as many countries pursue different tactics in fighting the pandemic, achieving a varying level of results.  In fact, China which has a “zero tolerance” policy in fighting COVID recently shut down the economically important port city of Shenzhen for more than a week, a city of more than 17million people, in an effort to halt a localized outbreak.  We expect this dislocation to remain, thereby muting the effectiveness of this as well as several more anticipated rate hikes through the balance of this calendar year. In fact, the fed must be careful as destroying end demand will not cure inflation as long as the supply chain issues persist.

 

The increases in prices at the pump as well as at food markets are obviously indicative of an overall inflationary environment at the wholesale as well as retail level.

 

The Producer Price Index, a measure of wholesale inflation, climbed 0.8% during February, this after rising1.2% during January (10.0%), a y/y record for the series that dates back to2010.  Energy prices rose 8.2% in February (33.8% y/y), this after rising 3.7% during January.  Finished food prices jumped 1.9% during February, this after rising 1.7% one month prior (13.7% y/y).  Excluding food and energy, the core PPI rose0.2% in February, rose 1.0% in January and by 8.4% y/y.

 

Meanwhile, the Consumer Price Index, a measure of inflation at the retail level, rose 0.8% during February, this following a rise of 0.6% in January and 0.6% during December(7.9% y/y).  This was the largest y/y increase for the CPI since January 1982. For the entirety of 2021, the CPI rose 7.0%, above the Fed’s 2% target and the fastest pace since 1982.  A key component of the CPI, energy prices rose 3.5% (25.6% y/y) during February, this after rising 0.9% during January.  Food and beverage prices rose 1.0% during February, by 0.9% during January and by7.9% y/y.  Excluding -food and energy, the core CPI rose by 0.5% during February, by 0.6% during January, by 0.6% in December and by 6.4% y/y.

 

Although welcome after a multi-decade period of losing real income, wages have begun to climb in a meaningful way as over the pasty ear average hourly as well as weekly earnings have both risen by more than five percent.  In fact, according to the Department of Labor there are several million more jobs available than there are individuals looking for jobs.  Until this imbalance can be rectified either through an increase in the labor force participation rate (currently around 62.3%) or through implementing additional technology, expect wages to continue to rise appreciably. FYI, on the whole we consider wage growth a welcomed repercussion from the evens of the last two years.

 

In our opinion, inflation will remain relatively robust well into the third quarter of this year and depending upon the situation in Ukraine, perhaps even longer.  However, we ultimately believe that the structural imbalances noted above will ultimately become less of an issue thereby allowing the current as well as anticipated future rate hikes by the Federal Reserve to take a firmer hold on the economy.  As measured by expectations, inflation has yet to embed itself in the broad economy and therein lies the hope of the Fed.  That is that they can subdue inflationary pressures prior to this occurring. For now, our money is cautiously on the Fed.  Time will tell.

 

Please note that all data is for general information purposes only and no meant as specific recommendations.  The opinions of the authors are not a recommendation to buy or sell the stock, bond market or any security contained therein. Securities contain risks and fluctuations in principal will occur.  Please research any investment thoroughly prior to committing money or consult with your financial advisor.  Please note that Fagan Associates, Inc. or related persons buy or sell for itself securities that it also recommends to clients. Consult with your financial advisor prior to making any changes to your portfolio.  To contact Fagan Associates, Please call 518-279-1044.

Similar Posts