Mind on Money: When will the inflation rate come down?
Marc Ruiz Times Columnist
As I meet with clients and talk to people out and about, one core question tends to dominate the conversation. The crux of this question is of course on everyone’s mind and will likely dominate the rhetoric surrounding the U.S. elections later this year. The question is “when are things going to stop getting so expensive?” Or, said in financial speak, when is the inflation rate going to come down?
I, of course share this question, as prices on anything we actually want to buy feel out of control to me. New pickup trucks, airfare, ski condo rentals, mountain bikes, steaks, pizza, bourbon, blueberries, coffee shop coffee and bacon, basically all the things I essentially want to spend money on to make life more enjoyable are all crazy expensive these days. I want some relief.
In our quest to explore the question of when things are going to stop being so expensive, we have to go back into the macro-economic logic underpinning the unpleasant inflationary trend we’ve all be experiencing.
As we all know, the inflationary cycle that started in 2022 was a result of Federal Reserve and federal government fiscal policy, combined with supply chain disruptions related to the COVID pandemic. The pandemic policy response from government at all levels was an inflationary perfect storm. Before we cast stones, however, I also believe that some of the inflationary policy responses kept our economy from slipping into recession or worse in 2020/2021. To stabilize our economy through the lockdowns and COVID fear, the federal government and Federal Reserve flooded the economy and financial markets with liquidity, aka new money, as a kind of medicine, so let’s call inflation one of the side effects that seem to dominate every drug commercial on TV.
The therapy for the inflationary side effect was the most rapid interest rate hiking cycle in the past 40 years. Higher interest rates have important impacts on the economy and markets, and are intended to reduce economic activity and cool the demand driving prices higher. In addition, the Federal Reserve was busy implementing other banking and open market polices to reduce the supply of money in the economy, and between 2022 and December of last year it was gently working with the money supply (M2) falling about 3.5% during this time. Less money in the economy should also reduce inflation, and as supply chains started to reconstitute these Fed polices had started to take the edge of increasing prices, until 2024. What happened?
Well remember, there were three main culprits behind the inflationary cycle. The Federal Reserve, global supply chain disruption and of course, the federal government. Two out of the three have been correcting, the federal government however, seems to have other agendas.
In early fall of last year, we discussed that over the fourth quarter of 2023, the federal government was going to have to issue almost $800 billion in new bonds to finance operations and satisfy ongoing bond maturities. I wondered at the time where this money was going to come from, in fact I was a little concerned that to raise this much capital, interest rates on the newly issued bonds would spiral upward. They didn’t, rates actually went down, which both surprised and confused me. Now I have a theory as to why, and it fits with observations on inflation.
One of the intended consequences of higher short-term interest rates controlled by the Fed is higher yields on savings accounts and money market funds, which are built with very short-term debt instruments. These higher rates attract deposits and the money sitting in these savings vehicles is not being spent, and thus not driving prices higher. It’s a win-win for the Fed as it tries to address inflation and for savers who like the yields.
My theory is that as the insatiable federal government sold bonds in the fourth quarter, some of these new bonds attracted money from savings accounts and money market deposits, and some money market funds pulled money from other debt instruments and bought short term U.S. Treasuries. Once the government had its hands on the money from the bond sales, much of it was immediately pumped into the economy in various social programs, entitlements and spending agendas. The result was the money supply stopped falling and has even gone up a little so far this year (source: Federal Reserve), which in my opinion is why the inflation rate resumed some momentum over the past two months. A very real example of why the talk of deficits and the national debt matter. As a nation, we need to get serious about this issue. Our ongoing prosperity is beginning to depend on it.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stock investing includes risks, including fluctuating prices and loss of principal. No investment strategy can guarantee a profit or preserve against loss. Past performance is not a guarantee of future results. This material may contain forward looking statements; there are no guarantees that these outcomes will come to pass.
Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at email@example.com. Securities offered through LPL Financial, member FINRA/SIPC.