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Inflation is always and everywhere a monetary phenomenon

By:  Michael Allbee, CFP® Principal| Senior Portfolio Manager

The past few months saw some eye-popping inflation readings after subdued inflation prints last year due to COVID. The Core Consumer Price Index (“CPI”), which excludes the volatile energy and food categories, rose 0.9% in June after increasing 0.7% in May and 0.9% in April, bringing the year-over-year reading to 4.5%. Headline CPI, which includes energy and food, rose to 5.4% year-over-year for the largest 12-month increase since August 2008.

A confluence of events drove these inflation outbursts: 1) the year-over-year inflation readings were expected to jump during the summer due to the low readings a year ago, 2) the speedy rollout of widespread COVID-19 vaccinations in the U.S. and fiscal stimulus unleashed pent-up demand faster than expected, catching many businesses off-guard, 3) the flow of goods ordered from overseas was slowed by shipping bottlenecks including the six-day blockage of the Suez Canal, 4) staffing issues are a contributing factor in the shortages, and 5) other one-off supply constraints (i.e., ransomware attack on a U.S. fuel pipeline, a brutal winter storm knocked out the power grid in Texas, and a global shortage of semiconductors).

Many economists (including those at the Federal Reserve) expect many of these price hikes to be short-lived (“transitory”) as output increases to reduce the bottlenecks.  In fact, roughly 90% of the CPI increase was accounted for by reopening price rebounds and supply disruptions. By far the largest contributor to the price rise in that category (accounting for over a third of the increase in the headline CPI) was used car purchases as new car sales were disrupted chip shortages. The other large contributor was transportation services, chiefly airline ticket sales. All the other categories (core services) barely budged. Despite three monthly increases, the 12-month increase in the shelter component, which constitutes nearly a third of the overall index, is still just 2.6%.

And add to this that as the supply constraints ease, year-over-year comparisons to the abnormal pandemic era are subsiding (May 2020 marked the pandemic low in the price index), the $300 federal enhanced unemployment benefit is expiring (many states have already ended it), many employers are re-opening offices, and school will soon be back in session.

However, while inflation might prove to be transitory, the longer-term path of inflation is still unclear and could depend on economic policy decisions yet to be made. Consider this. Inflation has been rising since last June, and yet the Fed has not changed policy one iota. It has been running monetary policy full steam ahead during rising inflationary pressures. Adjusting for inflation, monetary policy has become easier as the real Fed Funds rate (adjusted for inflation) has fallen from -1.1% to -4.4%. This is the result of their new policy framework not to raise interest rates preemptively but to seek maximum employment and deal with inflation later.

Given that “inflation is always and everywhere a monetary phenomenon” as famously said by Nobel laureate Milton Friedman, our goal as your advisor is to construct a risk-appropriate portfolio that will withstand any one of numerous economic scenarios that may unfold, including a scenario of high inflation.

One of my favorite quotes is attributed to Roman philosopher Seneca: “Luck is what happens when preparation meets opportunity.” At BFSG, we had already prepared our portfolio for an inflation scenario before coming into this year by reducing our exposure to long-term bonds, holding Treasury Inflation-Protected Securities (TIPS), initiating and adding to our gold position, holding international stocks denominated in foreign currencies, and having discussions with clients to reduce exorbitantly large cash reserves in low yielding savings accounts. We believe we will have an opportunity as inflation subsides over the next year to build these positions further and possibly add other real assets (i.e., real estate, natural resources, etc.). We believe our portfolios are prepared to meet the opportunity to enable our clients to withstand inflation and other challenges that will inevitably come our way.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s web site or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please see important disclosure information here.

Monthly Economic Summary (June 2021)

Last month was an interesting month for the markets and below is the economic summary for June.  As always, if you have any questions or want to discuss more in-depth do not hesitate to give us a call!

Sources:

  1. Sources: J.P. Morgan Asset Management – Economic Update; Bureau of Economic Analysis (www.bea.gov); Bureau of Labor Statistics (www.bls.gov); Federal Open Market Committee (www.federalreserve.gov)
  2. Indices:
    • The Barclays Aggregate Bond Index is a broad-based index used as a proxy for the U.S. bond market. Total return quoted.
    • The S&P 500 is designed to be a leading indicator of U.S. equities and is commonly used as a proxy for the U.S. stock market. Price return quoted.
    • The MSCI ACWI ex-US Index captures large and mid-cap representation across 22 of 23 developed market countries (excluding the U.S.) and 27 emerging market countries.  The index covers approximately 85% of the global equity opportunity set outside the U.S. Price return quoted.
    • The MSCI Emerging Markets Index captures large and mid-cap segments in 26 emerging markets. Price return quoted (USD).

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s web site or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please see important disclosure information here.

Why the Markets Ignored the Fed

By:  Thomas Steffanci, PhD, Senior Portfolio Manager

On Wednesday, June 23, 2021, the minutes of the Federal Reserve’s (the Fed) latest policy meeting held a week earlier were released along with individual members’ (anonymous) estimates of where the Federal funds rate will be through 2024. The policy setting group (the Federal Open Market Committee) is comprised of 18 members including Chairman Jerome Powell.

The content of the minutes was a “stunner” according to market pundits. Of the 18 Fed officials, 13 estimated that the Fed would likely raise interest rates twice by late 2023, up from 7 members in March. And seven of those 13 members expect interest rates to rise next year vs. three in March.

Why the shift? The committee’s average estimate of annual inflation in 2021 was increased from 2.4% to 3.4%. This may not sound like a big deal, but it assumes that inflation is going to run hotter in the remaining months of this year than formerly expected. Undoubtedly, the latest surprising May inflation number of 5% compared to a year ago turned the Fed heads’ March projections to dust for the ensuing 3 years.

The market was caught off guard by these changes. The 10-year Treasury bond yield leapt from 1.48% to 1.60% immediately following the release, and the Dow Jones Industrial Average (the Dow) lost about 300 points and closed lower the next two days. But bond yields wound up getting back to where they were during that two-day period before all this happened. Putting a capstone on this, the Dow is up 3% from its low post-Fed level.

So, the “stunner-in-the-summer” turned out not to be. There have been various reasons given for this. One has it that Chairman Powell harnessed a few fellow members to argue publicly that these estimates are individual member projections which in the past turned out to be wide of the mark. Another was that the committee did not discuss the timing of “tapering” their purchases of Treasury and mortgage securities or the extent of any interest rate changes.

But the markets’ ultimate reaction was more fact-based than that. The Fed’s latest meeting utterances were not “hawkish” at all. Consider this. Inflation has been rising since last June, and yet the Fed has not changed policy one iota. It has been running monetary policy full steam ahead during rising inflationary pressures. Adjusting for inflation, monetary policy has become easier as the real Fed funds rate has fallen from -1.1% to -3.8%. This is the result of their new policy framework not to raise interest rates preemptively but to seek maximum employment and deal with inflation later.

So, appearing to be hawkish to Wall Street know-it-alls, under their new framework the Fed is not going to get ahead of the curve to stem inflation. Even those on the committee who see a higher Fed Funds rate in 2022 are only penciling in a .75% level, a mere half percent higher than the upper Fed range now.

The Federal Reserve told the world and importantly the stock and bond markets that they expect to maintain a negative Fed funds rate for at least the next 2½ years. With the real cost of money an enticingly negative 4% or more, why should the markets give any credence to what the Fed says otherwise? Pay attention to what they do and ignore the rest. That is what the market understood this week.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s web site or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please see important disclosure information here.

“It’s Your Money” Workshop Series

BFSG’s Senior Portfolio Manager, Michael Allbee, CFP® and Senior Financial Planner, Paul Horn, CFP®, CPWA®, were invited to be guest speakers for the “It’s Your Money!” workshop series put on by Peter Kote for his not-for-profit Financial & Estate Literacy. These workshops educate seniors to take control of their financial, estate, and charitable giving decisions. You can check out the entire series HERE.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s web site or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please see important disclosure information here.

Economic Summary – May

Last month was an interesting month for the markets and below is the economic summary for May.  As always, if you have any questions or want to discuss more in-depth do not hesitate to give us a call!

Sources:

  1. Sources: J.P. Morgan Asset Management – Economic Update; Bureau of Economic Analysis (www.bea.gov); Bureau of Labor Statistics (www.bls.gov); Federal Open Market Committee (www.federalreserve.gov)
  2. Indices:
    • The Barclays Aggregate Bond Index is a broad-based index used as a proxy for the U.S. bond market. Total return quoted.
    • The S&P 500 is designed to be a leading indicator of U.S. equities and is commonly used as a proxy for the U.S. stock market. Price return quoted.
    • The MSCI ACWI ex-US Index captures large and mid-cap representation across 22 of 23 developed market countries (excluding the U.S.) and 27 emerging market countries.  The index covers approximately 85% of the global equity opportunity set outside the U.S. Price return quoted.
    • The MSCI Emerging Markets Index captures large and mid-cap segments in 26 emerging markets. Price return quoted (USD).

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s web site or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please see important disclosure information here.