A Year of Rising Inflation
Consumer prices in the US increased 7% over the last year, the highest rate of inflation since 1982. Here’s a breakdown of price increases from the latest CPI report:
- Gasoline: +49.6%
- Fuel Oil: +41.0%
- Used Cars: +37.3%
- Gas Utilities: +24.1%
- Meats/Fish/Poultry/Eggs: +12.5%
- New Cars: +11.8%
- Overall CPI: +7.0%
- Food at home: +6.5%
- Electricity: +6.3%
- Food away from home: +6.0%
- Apparel: +5.8%
- Transportation: +4.2%
- Shelter: +4.1%
Of all these categories, the most surprising has been the sustained price increases in used cars and trucks, which are 37% higher than a year ago. Supply chain issues in semiconductors continue to be a contributing factor that has not yet abated, so for now, the supply/demand imbalance remains.
There is strong evidence pointing to the actual inflation number being higher and that we'll likely see CPI trending higher over the upcoming months.
The CPI index (inflation) is calculated on a 12-month trailing basis to show the price changes in the goods and services we use as a society. Consider when supply shortages started and when you started to see real estate values in your own neighborhood begin to increase. Much of this started in the spring and summer of last year.
Also consider that 33% of the CPI index is in the "shelter" (housing) category, which was estimated to have increased only 4.1% over the last year. What's the problem with that number?
US home prices were up 19% year-over-year, which is one of the largest annual increases ever!
Actual rents were up 17.8% in 2021, the highest increase on record.
How to slow rising prices (and tame inflation) ?
That is the question everyone is asking and the answer is easy, STOP the cheap supply of money.
As it pertains to the booming housing market, it will slow as interest rates rise. When mortgage rates rise, the affordability of a home for the average consumer declines, meaning a higher monthly mortgage payment.
The 30-year mortgage rate in the U.S. rose to 3.45% last week, its highest level since March 2020. Only a year ago it hit a record low of 2.65%.
Why are mortgage rates finally moving higher?
They are losing the artificial support of the Federal Reserve ("Fed"), who started slowing down their purchases of mortgage bonds last December and are expected to end all quantitative easing by March.
Additionally, the Fed is now expected to hike rates 4 times this year, with a year-end Fed Funds Rate of 1.00-1.25%. The bond market is quickly repricing to this new reality, with yields racing back to pre-pandemic levels.
Even with 4 rate hikes, current monetary policy could hardly be described as restrictive, but this is an important change nonetheless, as the beginning of the end of easy money has arrived (for now).
Is Inflation the new normal?
Is inflation transitory or permanent? This is a hotly debated topic, especially since inflation is difficult to forecast and the markets haven't been great at predicting long-term levels of inflation. It’s important to note that the market perceives these elevated price levels to be more temporary in nature and less a permanent structural shift. The market uses “breakeven rates” to show what the perceived level of inflation will be across various maturities into the future, by calculating the difference in yields between treasury inflation-protected bonds (TIPS) and regular treasury bonds.
There are reasons this post-pandemic inflation is transitory (supply shortages, elevated asset prices, surging consumer demand, rising interest rates), while there are other reasons that price levels could remain elevated more permanently (demographics, wage gains are sticky, housing supply shortages, excess liquidity).
Often times, the answer can be found somewhere in the middle. This story will be closely monitored by central banks and investors alike for the weeks, months, and years to come.
As we outlined in our 2022 outlook, we are expecting a very choppy year where inflation and interest rates will be one of the biggest contributors to volatility. As interest rates rise, there will be a a repricing of asset values, including real estate, automobiles, stocks and bonds. How do rising interest rates and changes in Central Bank policy impact various areas of the markets? We continue to study and review research on past inflationary periods for a roadmap on where investors should be allocated through this period of time.
If you have questions or to review how your portfolio is allocated, please contact us to discuss.