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How Long Will Inflation Stick with Us?

How Long Will Inflation Stick with Us?

There is no lack of inflation data that we see on a near daily basis; however, the question remains – how long will this elevated inflation level last?

With all the talk of inflation, several terms are thrown around: CPI, Core, PCE, and more – ad nauseam. Core CPI is an attempt to strip out the most variable drivers of inflation (namely food and energy) from the base (or “headline”) CPI number, but the costs of food and energy can infiltrate into core CPI items such as apparel and household goods.

One index that is less discussed is the notion of Sticky Inflation, which examines how price changes can vary at shockingly different rates. This concept is examined by the Federal Reserve Bank of Cleveland in their post, “Are Some Prices in the CPI More Forward-Looking Than Others? We Think So”:

“The most comprehensive investigation into how quickly prices adjust that we know of was published a few years ago by economists Mark Bils and Peter Klenow. Bils and Klenow dug through the raw data for the 350 detailed spending categories that are used to construct the CPI. They found that half of these categories changed their prices at least every 4.3 months. Some categories changed their prices much more frequently; price changes for tomatoes, for example, occurred every three weeks. And some goods, like coin-operated laundries, changed prices on average only every 6½ years or so.”

Bils and Klenow then developed a methodology that separated these “sticky” priced items– items that changed prices less than every 4.3 months– from the “flexible” items– items that changed more frequently than 4.3 months on average. Intuitively this should make sense since it is far easier to raise the prices on tomatoes than it would be to increase rents in a residential building where the tenants have long-term leases.

Recent History of Sticky Inflation

Viewing the last 10 years, let’s take a look at the Sticky CPI versus Flexible CPI and see what we can take away from this chart.

In my opinion, it is important to note that Sticky CPI over the last 10 years was really sticky, and low overall. Looking into the Flexible CPI, particularly in 2015, the main driver of deflationary pressures was energy. We had a low overall print on CPI that year but it appeared to have almost no impact on Sticky CPI. Here’s where I begin to worry a bit about the longer-term sustainability of heightened inflation; despite gas prices being on a record 99-day decline (that just ended), there is no guarantee that any of that will affect Sticky CPI. The chart may be a little misleading since the upslope looks fairly gentle – in January 2021 the 12-month Sticky CPI was 1.7%, and in August it was 6.1% on a quickly rising curve. Given how stable the sticky CPI has been over the last 10 years, this increase in Sticky CPI in two years is significant and could prove meaningful to how we interpret future inflation. 

How Much Does Sticky CPI Influence Headline CPI?

According to the Cleveland Fed, In terms of the overall, or ‘headline’ CPI, we judge that about 70% of it is composed of sticky-price goods and 30% of flexible-price goods.” If this is the case, inflation may be around longer than we’d hope, and certainly well above the Fed mandate of 2%. The rate traders are not necessarily agreeing that this is the case, however. The forecast there is that rates will peak in the first half of 2023, with interest rate cuts later in that year. 

This is what the inverted bond curve we’re currently seeing (see link below) is predicting: The Fed overshoots the rate increases, causes a significant economic slowdown (recession), inflation falls quickly, and they immediately have to reverse course to bail out the ailing economy. To think that we will reverse course so quickly in having to cut interest rates is a bit hard to imagine, though noted bond trader Jeffrey Gundlach and celebrity ETF manager Cathie Wood are already talking deflation. Call me skeptical. A better bet may be that we see a less aggressive Fed in 2023 than this year, with a waiting period at some point to see if the inflation data is trending in the right direction. 

In a very uncertain economic picture, one thing is clear – significantly more recessionary headwinds are present than 12 months ago, and the Fed has the unenviable position of trying to navigate a soft landing. Let’s all hope that the inflation we are experiencing won’t be so sticky after all. 

AUTHOR

Clint Walkner

Clint Walkner

Financial Advisor

Clint Walkner is one of the co-founders and managing partners of Walkner Condon Financial Advisors. He is a fee-only, fiduciary financial advisor who works with clients locally in Madison and around the country.

Recency Bias and the Fed’s Interest Rate Hikes

Recency Bias and the Fed’s Interest Rate Hikes

On every vacation we go on, my kids say something to the effect of, “This is the best vacation ever!” I typically follow up that statement with the question “What about that other vacation you said was the best?” And they respond, “Oh yeah! That was my favorite too!”

Is each vacation we take truly the “best” we’ve ever been on? Are we just upping the ante and topping each trip we take with a more exciting one? Nope. So then why do they think that each vacation we take is the best ever? Recency bias.

Recency bias is a cognitive predisposition that causes people to more prominently recall and emphasize recent events compared to those that occurred further in the past. My kids claim our current vacation is the best because it’s fresh in their minds, and they remember it most clearly.

When it comes to investing, recency bias shows up in many different ways: picking a stock or fund based on a recent surge in performance, overweighting a particular asset class due to recent outperformance compared to other sectors, assuming the current bear or bull market will continue, and generally losing sight of longer-term trends in things like gas prices, interest rates, and inflation.

Look no further than the current discussion of the federal funds rate. For reference, the current federal funds rate is 3.25%. A year ago it was .25%. 

So, if you look only at the recent history of interest rates, this may seem like a large jump. However, when you take a longer view and look at historical interest rate trends, we are still far below historical averages. Even news outlets use adjectives like “aggressive” and compare the current rate to the “most recent high in summer 2019.”

When you zoom out, looking beyond this recent time of uncharacteristically low interest rates, you’ll see that even with these increases, interest rates are still at historic lows. Over the past 60 years, the average federal funds rate has been just above 4.6%. From 1977-1991 the rate didn’t drop below that average and soared as high as 20.6% in 1981. We have had below-average interest rates since 2008. And even with the most recent increase, we’re still below historical averages.

Despite the historical data, the market reacted negatively over the last week to the news that the Fed is continuing to be more hawkish on inflation, with expectations of multiple interest rate increases in the next 12 months. 

Why this is somewhat of a surprise is confounding, as an important chart should be referenced:

Is the Fed “tight”? Hardly. Historically the Fed funds rate has been over inflation, and in some cases, for years. Unless supply chains heal quickly or we see a significant recession, in my opinion, we are a long way away from pausing rate hikes if we actually want to be serious about slowing inflation.

Low interest rates are fresh in people’s minds. It’s easy to focus just on that most recent data, especially when low rates have persisted for so long. When I remind my kids of a larger vacation we took a year ago (like Florida), suddenly the weekend we just spent up north is no longer “the best vacation ever.” It just takes a little reminder to put recent events into perspective. Hopefully, being reminded of longer-term trends, and adding more data points to the interest rate conversation, will widen people’s views and help eliminate some of that recency bias.

Note: The opinions expressed are the author’s views but may not reflect those held by other advisors at Walkner Condon Financial Advisors. 

AUTHOR

Alicia Vande Ven, M.S.

Alicia Vande Ven, M.S.

Financial Advisor

Alicia Vande Ven is a Candidate for CFP® Certification at Walkner Condon Financial Advisors, a fee-only, fiduciary financial advisor firm based in Madison, WI, that works with clients locally and around the country.

 

Inflation Nation: What’s Behind the Current Inflation?

Inflation Nation: What’s Behind the Current Inflation?

If we think back to the outset of 2021 – which feels more like 10 years ago than a year and a half – it was easy to overlook inflation, while we focused on rolling out COVID-19 vaccines and the start of a new presidency. But the problems we’re currently facing with the rise in inflation were percolating under the surface. 

Back in Dec. 2020, the Federal Reserve estimated that the Personal Consumption Expenditure Price Index (PCE), which excludes food and energy prices, would rise by 1.8%. By the time June 2021 rolled around, that was up to 3%. And by the end of 2021, it was at 4.1%. With all of the issues that our economy faced as we clawed back from the COVID-induced market downturn, the Fed was hesitant to raise rates too quickly, as it tried to navigate more pressing economic matters. 

The Consumer Price Index (CPI) provides further evidence of inflation. The most recent figures at the end of June showed CPI had increased to 9.1%, the highest 12-month increase in 40 years. 

So, how have we gotten to this point with inflation? The Fed continued to keep interest rates low as they injected the economy with new money in the early stages of COVID-19. There are several reasons that we are dealing with record inflation, but this factor should not be overlooked. 

Another phrase bandied about over the last year-plus is ‘supply chain issues.’ Any time there is a high demand for goods and services, but there is a low supply, you will see prices rise. Now past the halfway point of 2022, we are seeing how this has played out. Though gas prices have begun to dip back below $4 a gallon in many states, they are still close to $4.50 per gallon nationally as of Aug. 5. This is having a drastic impact on the companies that rely on fuel to get their products through the supply chain. It is also impacting consumers as they are spending far more on filling up their tanks than before, which in turn leads to less saving and less spending on items that are non-essential. When you couple that with the Federal Reserve raising interest rates to 2.50%, there is uncertainty about our economy. 

The crisis in Ukraine has also played a key factor in these rising energy costs, particularly in fuel, an impact that can be seen in the CPI number. Russia invaded Ukraine on Feb. 24, and the price in gasoline in the U.S. began its rapid ascent shortly thereafter, with its steepest climb in the first half of March.

Lastly, COVID-19 created many fissures in our economy. Employees have had increased leverage to leave their current jobs, while employers have struggled to find enough employees, including a restaurant in Texas that asked for volunteers to make sandwiches in return for one free sandwich. 

It would’ve been hard to anticipate at the start of 2021 that all of these factors would have coalesced to bring us to our current situation. But regardless of how we got here, we’re still in the thick of this inflationary environment. We’ll receive July’s inflation numbers on Aug. 10, which may give a better picture of the impact of the Fed’s decision to increase interest rates. 

And there is a chance that we could go into a recession, which could be painful in the short-term. But if history is any lesson, we will emerge from the current downward trend. And especially during times like this, it’s important to have a plan and stick to it through diversification and owning quality assets and asset-classes. 

AUTHOR

Jonathon Jordan, CFP®, CEPA

Jonathon Jordan, CFP®, CEPA

Financial Advisor, PARTNER

Jonathon Jordan is a Certified Financial Planner ™ and Certified Exit Planning Advisor at Walkner Condon Financial Advisors. He is a fee-only, fiduciary financial advisor who works with clients locally in Madison and around the country.

Webinar: State of the Market Halfway Through 2022

Webinar: State of the Market Halfway Through 2022

When it comes to finances and investing, 2022 has started in a rocky fashion. The lasting impacts of COVID-19 – including its continued effect on supply chain snags – and Russia’s invasion of Ukraine have had a hand in the increasing impact of inflation, as well as the rollercoaster ride of the stock markets. And regardless of whether you have an advisor or you manage your own investments, you’d be lucky to be down only a few percent year-to-date.

With an underwhelming last six months in the books, we felt it was an important time to have a transparent conversation about the state of the market. And while this is geared toward our clients, we cover lots of ground that every investor should know right now from stock performance year-to-date to treasuries and mortgages to the inverted yield curve.

Questions or Comments?

If you have any questions or would like to discuss anything from the State of the Market webinar more in-depth, please feel free to reach out to our team by tapping the button below. You can also schedule an appointment by clicking here.

Making Up For Lost Time: Prepping for Return to Normal Spending in 2022

Making Up For Lost Time: Prepping for Return to Normal Spending in 2022

I originally wrote this blog post in July 2021. I am updating the post as a great deal has changed in our lives since last summer. We are still dealing with the impact of COVID on a daily basis; albeit, it is in many different ways. Our consumer habits are much closer to pre-pandemic patterns. We are dining in restaurants and shopping in stores. Travel is returning to more normal levels as well. All of that said, we are still a country very much dealing with this virus. Our hospitals are better equipped to handle life-threatening cases and, fortunately, those case numbers are falling. We are still seeing friends and family members test positive at a high rate, and we are frequently utilizing home testing kits to determine the cause of symptoms. I believe that most people are coming to the realization that COVID will be us, in some form, for many years to come.    

Through the first year and a half of the pandemic, we heard the phrase “new normal” ad nauseam. Pundits and media types love to tell us that this is a different time, situation, or environment than we have ever seen before. I tend to look skeptically at these prognostications because history has a way of repeating itself. However, this won’t be a new normal as much as a move toward “back to normal,” not only in our personal and social lives but also in our financial lives. 

In the chart above, 2020 became one of only two years since 2000 that Americans’ personal savings rate eclipsed 10%. Click here for the interactive chart. Source: Statista.com

Savings Rates Are Off Of Their Early Pandemic Highs

We all were forced to adjust our lives and adapt to a COVID world. We all stayed at home more and limited our exposure to crowded situations. A silver lining emerged from this very difficult period in our lives by way of our personal savings rates. Personal savings rates in the United States skyrocketed in 2020. The savings rate in 2020 was almost double that of 2019 and more than doubled the respective rates of 2016 and 2017

That’s changed over the last year. Savings rates have fallen off of their pandemic highs, dropping in all but two of the last 13 months since March 2021 and trending below the 10-year average. The recently released rate for the month of April shows that the savings rate for Americans hit its lowest level since 2008 (4.4%). This is likely a result of people’s spending habits returning to pre-pandemic levels as well as an increase in the cost of goods. Inflation is having a very real impact on household budgets. For this reason, we should review our cash/emergency savings levels and determine if we need to allocate more of our income to short-term savings accounts. The economy is facing headwinds that we haven’t seen in some time, and we should all be prepared for a possible slowing of economic growth. 

The Challenging Beginning to 2022

The domestic stock markets are dealing with myriad economic issues as we near the mid-year point. Supply chain issues caused by COVID shutdowns are still generating disruptions with companies trying to deliver finished products and keep shelves stocked. As a result, companies are having to forecast lower revenue projections, and the equity markets are reacting negatively. This, in conjunction with a bond market facing strong indications from the Federal Reserve of significantly higher interest rates, is stressing the fixed income markets and yielding an uncertain second half of 2022. The country is also seeing a shift away from work-from-home employment to workers going back to offices, stores, and production facilities. This puts pressure, particularly on technology companies such as Zoom, DocuSign, and others, which soared in the WFH environment and are now struggling to adjust to employees traveling back to work.

Assess Your Financial Situation 

Your financial life is in a different place than it was at the beginning of 2020. 

We are all attempting to find the correct footing for ourselves and our families in this post-pandemic, but still lingering COVID world. From a financial perspective, it is important to keep in mind that correctly positioned emergency funds are imperative. It is difficult to predict how 2022 will finish and where the economy will sit at this time next year. For that reason, reviewing your financial plan and understanding the impact of recent market downturns have had on your plan is critical. Prioritizing your financial situation during these times will most likely produce better results as the country hopefully gets beyond this current phase of COVID. 

Nate Condon, Financial Advisor