The Federal Reserve vs. Inflation

The past few years have felt like a heavyweight boxing match between two formidable opponents: inflation and the Federal Reserve. Inflation started the fight strong, but the FED's countermeasures of interest rate hikes and balance sheet runoff have somewhat subdued its momentum. However, certain factors have reignited inflation, including stealth quantitative easing (i.e., non-traditional means to increase money supply such as Treasury General Account spending), supply chain disruptions (such as those caused by the Red Sea incident), and consumers' continued willingness to leverage their personal balance sheets.

Once deemed inevitable, a potential 25-basis point rate cut in June looks unlikely following the heightened inflation data reported for March along with Powell’s subsequent comments that he believes it’s appropriate to allow restrictive policy further time to work. Elevated inflation persists in sectors like shelter, transportation services, and fuel, dampening prospects for rate cuts. While some areas show signs of stabilization, the overall economic landscape remains mixed with no clear trajectory.

Analyzing the various factors contributing to inflation and formulating behavioral finance hypotheses to create future inflationary projections have been both fascinating and challenging. Economic metrics like the Consumer Price Index (CPI), Personal Consumption Expenditures (PCE), and the velocity of money have become obscured due to the unprecedented quantitative easing during the COVID-19 era. One example of this is the M1 velocity calculation which shows how quickly liquid money is exchanging hands. Typically, when velocity increases so does inflation, so one would think that it’s currently elevated. Instead, the figure has become diluted since the amount of M1 money supply in circulation has increased by multiples over the last few years, being held in money market funds and banks therefore never exchanging hands. However, enough of that excess cash is still flooding the system and keeping inflation elevated but the calculation is showing low velocity as only a portion of that stimulus is moving through the system.

This is just one example of many indicators no longer having much explanatory power making it harder to navigate and forecast future inflation expectations and thus a winner of the boxing match. Instead of relying solely on economic analyses conducted by the Federal Reserve, it's crucial to assess real-world indicators to gauge inflation. As crude as it may seem, observing things such as high foot traffic in bars and restaurants or seeing where gas prices are trending can help with future projections and forming hypotheses.

For instance, on almost any given day most restaurants and bars are packed with young adults. If you talk with enough of them most have been priced out of real estate. Given the significant economic activity despite increasing costs, this leads us to the hypothesis that young people, facing barriers to asset acquisition like purchasing a home, are instead opting to spend disposable income rather than save. This creates a feedback loop of spending more because of the unaffordability of homes, increasing inflation and keeping the cycle running on and on.

It seems like this boxing match will continue until there’s such a strain on the consumer that inflation is stopped in its tracks. However, as high job availability continues and unemployment stays at historical lows, the fight continues. Inflation may be able to throw a few more jabs before we reach the final round.

Portfolio positioning for multiple outcomes is crucial, with a balanced mix of shorter maturity bonds to hedge equity market volatility while maintaining exposure to equities and alternatives to hedge against potential and current inflationary pressures. This barbell strategy from a macro sense offers simplicity and effectiveness in navigating uncertain economic terrain where any overconcentrated position on either end could create a lopsided risk/return dynamic.

Josh L. Galatzan, CIMA®
Founder & Managing Partner

Kirk Price
Managing Partner

Chris J. Popso
Wealth Management Associate

Brian J. Noonan, CEPA
Managing Partner

Meagan Moll, CIMA®, CFP®, CPWA®
Managing Partner


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