By: AnnaMarie Mock, CFP®
Inflation is all everyone has been talking for the past few years. Inflation reaching 40-year highs has wreaked havoc on consumers' wallets and caused market uncertainty.
2021’s Inflation Story
The inflation story in 2021 was propelled forward by supply chain disruptions following the shutdown of the economy due to the COVID stay-at-home orders. This broad statement of supply chain disruptions expands to the physical transportation of products and a shortage of workers and materials.
Durable goods like appliances, lumber, cars, and electronics were on a skyward trajectory because of the expenses of producing, shipping, and distributing them. These issues were labeled transitory but proved to be sticky, with consumer demand exceeding supply.
According to Carl Quintanilla, a journalist from CNBC, the cost of shipping containers crossing the Pacific was around $20,500 in September 2021, dropped to $13,700 in January 2022, and is now at $2,300. That is a reduction of 89% in one year.
Although the bottleneck issues are not fully resolved, it is no longer as much of a contributing factor to inflation.
2022’s Inflation Story
In 2022, energy was the most significant addition to inflation, which began to increase steadily in January. With the unfolding devastation caused by the Russia/ Ukraine crisis, countries imposed sanctions on Russian oil. The supply of oil decreased, but the demand remained constant.
In January, the national average price per gallon was $3.40 compared to $5.00 in June. Month over month energy continuously increased until the peak in June.
Source: JP Morgan – Guide to The Markets
Other categories like hospitality services and shelter similarly increased this year but have not shown any signs of reprieve.
Inflation reversal is not immediate and can lag for specific sectors. The increased food preparation costs and higher employee wages for restaurants are passed along to the consumers, keeping inflation elevated for longer.
What Has Been Done to Counteract Inflation?
The Federal Open Market Committee (FOMC) controls interest rates through monetary policy and tools available to control the money supply and foster sustainable growth. The FOMC has increased the federal funds rate in 6 out of 7 meetings this year, with one more meeting scheduled for December. These policy decisions limit the money supply to intentionally slow growth, reduce consumer demand, and decrease inflation with the long-term objective of stabilization.
The year started with a federal funds rate of less than 0.25% and is now at about 4.00%. Below is a chart showing the increase per meeting this year and the targeted federal funds rate.
Source: https://www.federalreserve.gov/monetarypolicy/openmarket.htm
This swift policy change (captured in the Increase column above) was intended to bring down inflation over time. There is a response lag between the monetary policy change and the actual time for the economic impact to be realized.
Alan Greenspan, chairman of the Federal Reserve from 1987 to 2006, aptly compared the monetary policy to a barge traveling on a river. "To successfully navigate a bend in the river, the barge must begin the turn well before the bend is reached. Even so, currents are always changing, and even an experienced crew cannot foresee all the events that might occur as the river is being navigated."
Like the crew on the barge, the FOMC is trying to anticipate what is needed now to get the desired outcome in the future without triggering a recession. It took months from the first-rate hike in March for the FOMC's policy decisions to positively affect the inflation figure and bring it down. Although inflation is still elevated, the October inflation reading was 7.7% versus expectations of 7.9%. The difference between actual and expected may seem nominal, but this is quite drastic compared to the peak in June, 9.1%, and September, 8.2%.
Federal Reserve Vice Chair, Lael Brainard, stated, "The inflation data was reassuring, preliminarily. It will probably be appropriate soon to move to a slower pace of rate increases... What's really important to emphasize is we've done a lot, but we have additional work to do both on raising rates and sustaining restraint to bring inflation down to 2% over time."
Francisco Fed President, Mary Daly, cautioned, "One month of data does not a victory make, and I think it's really important to be thoughtful that this is just one piece of positive information, but we're looking at a whole set of information." This is a reminder that there is still more work to be done by the FOMC, but we can be cautiously optimistic that the road to recovery has begun.
Regardless of how long recovery takes, the most important thing for investors to focus on has a purpose-driven financial plan that incorporates today's needs with tomorrow's goals. A financial plan's success is centered around staying invested and focused for the long term without reacting to events like market drawdowns or elevated inflation.
AnnaMarie Mock is a CERTIFIED FINANCIAL PLANNER™ and Partner at HIGHLAND Financial Advisors, LLC, a Fee-Only financial planning firm that offers comprehensive financial planning, retirement planning, employer retirement planning, and investment management. AnnaMarie graduated from Montclair State University with a degree in finance and management and successfully passed the CFP® national exam in 2016. She has been working at Highland Financial Advisors since 2013 as a fee-only, fiduciary Wealth Advisor and is a member of NAPFA.