🦠 Inflation Infection - How Easy Money and GDP Growth Will Embed Inflation
At last week's post-Fed meeting press conference, Fed Chairman Jerome Powell gave forward guidance on the future path of the central bank's interest rate policy, messaging seemingly coming directly from the plot of an Orwellian novel or from an '80s British Pub Rock Band.
For those not baptized in the glory of Dire Straits or their song, Money for Nothing, this epic music video is well worth the 4 minutes and 38 seconds to become acquainted. Though, this must also come with a disclaimer: it's not a very P.C. song, and I'd advise that it is #NSFW.
Moving along, the Fed's decision to keep interest rates where they have been since July 2023 was expected, and so, too (by the markets) was the guidance for future interest rate cuts. And as a consequence, we are being led down the path towards monetary easing (easy money) on the horizon, and hence why "Money for Nothing" has been stuck in my head since last Wednesday.
To be clear, last week, I stated that Powell would not commit to cutting interest rates - and I was wrong. My mistake was in believing that Powell would do the right thing for #thepeople and not ease monetary policy given the reaccelerating inflation data trends over the past handful of months. Shame on me for attempting to predict the decisions of an unelected public servant political creature.
But, I also said that if they do cut rates with these inflation trends, it would be a monumental mistake, as U.S. and global economic growth is projected to reaccelerate through the end of this year.
So, let's investigate why lowering interest rates will cause the economy to become infected with long-term, structural, embedded inflation.
Fed fund futures imply three rate cuts by year-end
To recap those inflation trends, the CPI stopped declining eight long months ago, is stuck in the +3% range, and recent months have shown a (re)acceleration in key inflation metrics such as core inflation and core services inflation.
The latest "core" inflation (CPI that excludes food and energy prices due to their high volatility) was +3.8 % year over year. And "supercore" inflation, which targets the rate of inflation in the economy's service areas, was a whopping +4.46%, marking its fifth consecutive month of (re)acceleration.
Further, the monthly headline CPI data has also been accelerating over the last five months. After the February report, the latest rolling 3-month annualized inflation rate is 3.6%!
Yet, we're supposed to close our eyes to the data and believe the words of a man that inflation is on its way back to their 2% target and not ask any decently-minded, logical questions.
Mind you, this man is the same man who called inflation "transitory" and then watched CPI jump from ~4% to 9.1% in a New York minute... but I digress.
Leading economic indicators turn positive
So, what's the problem?
If inflation remains sticky high, the economy heats back up, and the Fed eases monetary policy, inflation will not only inflect back higher but also infect the economy at fundamental and structural levels. The chart above shows that leading economic indicators (LEI) have bottomed and are moving upwards.
Although they are still negative on a year-over-year basis, the last handful of months of sequential data show a positive inflection, which, on the margin, is a bullish sign for the economy. And, as the name implies, it indicates that the economy is in the early stages of reaccelerating.
Further, the chart below shows how Global Purchasing Manager Indices, another leading indicator for global economic activity, have also bottomed and reaccelerated to the upside.
While notable, Europe is technically still in contractionary territory; the strong sequential reacceleration growth trend established in July of '23 will likely have them advancing back into positive growth in the next few months.
Global PMIs show a reacceleration in global economic activity
This corroborates our research team's economic projections that real-GDP (inflation-adjusted) growth is likely to clock in at +4.15% annualized growth for the second half of 2024. Economic growth is crucial to understand here because it is a massive driver of reported inflation metrics.
In simple terms, the greater the economic activity, the greater the demand for goods and services, which in turn keeps the costs of said goods and services increasing. This further corroborates the research team's sticky high headline inflation forecast of +3.3% annualized CPI growth for the back half of 2024.
Headline inflation of +3.2-3.4% and core inflation measures in the high 3's and mid-4's, and reaccelerating, with economic growth reaccelerating, is not an environment in which inflation will return to the 2% target anytime soon. And easing monetary policy from here through cutting interest rates will only make matters worse.
This is precisely how inflation becomes embedded (infected) in an economy. As unfortunate as that is for #thepeople, given that inflation is essentially a regressive tax system that disproportionately affects the low ends of the wealth and income distributions (continuing K-shaped recovery), we can use this information to make prudent tactical asset allocation decisions to protect our hard-earned wealth by investing in inflation-fighting and inflation-resistant assets.
The bottom line: The fight against inflation is far from won, and the reacceleration in global economic growth and The Fed's monetary easing will only make the battle harder in the long run. However, knowing these trends and policy errors can make for favorable dynamic asset allocation adjustments to protect and compound your wealth.
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Matt Faubion, CFP®
Founder - Wealth Manager
This article is for informational purposes only and is not a replacement for real-life advice, so make sure to consult your tax, legal, accounting, and financial professionals if you want more information. This content is developed from sources believed to be providing accurate information, and provided by Copyright (c) 2024 Faubion Wealth Management LLC. All rights reserved. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.