Have we hit peak inflation? The idea that this might be the case has lured investors back into risky assets over the past few months. U.S. inflation, CPI, eased slightly to 8.5% in July, down from 9.1% in June. This is primarily due to falling gasoline prices. Core CPI, which excludes energy and food items, printed a 0.3% gain, down from the sharp 0.7% gain in June.
The story that many are telling is this: lower inflation levels will allow the Fed to back off its aggressive interest rate hike policy, a boon for investors to pile back into risk assets. As such, investors have begun to pile back in.
However, this may be premature. As we all know, the Fed is attempting a ‘soft landing’ by raising rates to cool inflation while not thrusting the U.S. into a recession. Time will tell if they can walk this tightrope, but history suggests otherwise.
Soft landings have always required the Fed to lower rates, not merely halting rate hikes. Therefore, if we use history as a guide, the Fed would have to lower rates if they hope to avoid a recession.
In this environment, it seems preposterous that the Fed would lower rates any time soon as inflation is still near record highs.
Inflation Is Caused By Monetary Policy
Furthermore, it is essential to remember that inflation is a monetary phenomenon. Rising inflation is caused by a more rapid increase in the quantity of money than the quantity of goods or services produced during the same time period.
In other words, if the nation’s printing press produces money at a greater rate than its economy can grow, the result will be higher inflation levels. I wrote about the risk of rising inflation as early as October 2020 as money printing began to reach unprecedented levels. As with all things, actions have consequences, and there is always a price to be paid. The Fed can temporarily lower inflation rates by slowing the demand for goods via rising interest rates. Though, this is not a long-term solution. The only way to solve the inflation dilemma is to stop printing money.
The good news is that we have started to do just this. M2 growth (the amount of money in our economy) has started to decline. While the total percentage change of M2 since the pandemic began (March 2020) is 40%, the year-to-date growth of M2 is flat (0% change).
Are We In A Recession?
The other big question we all seem to be facing is whether or not we are currently in a recession. While sentiment seems to have turned positive over the past few weeks, suggesting that the worst is behind us, economic indicators tell a contrasting story. Leading indicators continue to trend down in the U.S. and globally.
If the current economic trends continue on the same path, we continue to see a (mild?) recession starting sometime by March 2023. While we have experienced two negative GDP prints over the past two quarters, we have yet to experience a recession officially.
According to the Economic Cycle Research Institute, a recession must experience a pronounced, pervasive, and persistent decline in output, employment, income, and sales. If we were to track these four indicators, three of the four have been declining to a point where one could argue that they are recessionary. Employment, while slowing, has not been declining. So, until we see the unemployment rate rise, we have yet to experience a recession.
The last time there was a recessionary debate was the 1990-1991 recession, which is commonly referred to as the jobless recovery. At that time, the economy was weakened due to a hawkish Fed attempting to quell higher inflation rates, the 1990 oil price shock, and depressed consumer and business confidence levels. Furthermore, the Tax Reform Act of 1986 lowered investment incentives and contributed to the end of the real estate boom of the mid-1980s.
The recession officially concluded in March 1991 when the economy posted positive economic growth rates. However, to many economists’ surprise, the unemployment rate continued to rise through 1992.
Because of this uneven recovery, there were considerable debates among economists when trying to pinpoint the recession’s end and the recovery’s beginning. In the end, the National Bureau of Economic Research (NBER) took 21 months to officially determine that the recession ended in March 1991.
No doubt, the NBER will look at this period and debate whether or not we are currently in a recession. Though, keep in mind that while the unemployment rate is at historic lows, the jobless rate is a lagging indicator. We might begin to see the unemployment rate rise soon as companies continue to feel the sales slowdown pinch. If inflation continues to squeeze businesses’ revenues and costs, they will most certainly trim their headcount. One of the quickest ways for a company to improve its profit margin is to cut nonessential staff. Though, of course, this all depends on the inflation rate, which is extremely difficult to forecast within the short term.
In the meantime, keep a cool head and ensure that your portfolio is well-positioned. If you would like to learn more about our firm, you can do so here. And if you would like to speak with us regarding your portfolio and financial goals, please feel free to do so here.
Thank you. Have a great weekend!