Previously published in The Bulletin, Bend, Oregon on January 16, 2022
Inflation. We have been hearing that word quite a bit since April when the Consumer Price Index (CPI) jumped 4.2% year-over-year. Prior to this, the CPI hadn’t exceeded 3% since December 2011. The most recent reading of the index for the period ending November 2021 climbed 6.8%, the largest 12-month increase since June 1982.
We have all experienced this rise in prices in one way or another, whether it be at the gas pump, (where we have seen a year-over-year increase of 58%), at restaurants (the food away from home category has increased 5.8%), or in the search for a new or used car (with increases of 11.1% and 31.4%, respectively). Much of these increases in prices are explainable if we think about what has occurred in our economy since the beginning of the pandemic. Prices in these areas began to decline in March 2020 when many parts of the country rolled out shelter-in-place rules and demand for these goods plummeted. Supply of new cars also fell as factories shut down production. As vaccines began to be administered in early 2021 and people started to venture out more often, demand for these goods sky-rocketed while supply could not keep up. Due to supply chain issues and ongoing disruptions from COVID-related shutdowns, supply has not quite caught up to demand to help quell the rise in prices, but we are beginning to see those issues recede.
A steady rate of moderate inflation can be positive for the economy and the stock market. It is a sign that the economy is growing, allowing companies to raise prices and increase the wages they pay to their employees. Inflation can become a problem for the economy and financial markets when it rises quickly and to a significant degree. This creates uncertainty as companies must adjust their planning to deal with higher prices for inputs in the goods they produce and how it will affect their profits. Consumers also struggle with the decision of whether to purchase goods now or wait for prices to decline. This can become a vicious cycle.
To try and keep inflation in check, the Federal Reserve maintains the pursuit of stable prices as one of its three key monetary policy objectives. The uncertainty for the stock market is how the Federal Reserve will react to the persistent rise in prices we have experienced over the past eight months. A misstep in policy and removal of economic support too soon could cause an economic slowdown. So far, Federal Reserve Chairman Jerome Powell has outlined the Fed’s playbook clearly – begin by tapering bond purchases followed by increasing the Federal Funds Rate. Following the Fed’s December meeting, Powell announced that the Fed plans to increase the rate three times in 2022 followed by another three in 2023.
The consensus expectation from economists is that inflation will normalize in 2022 as supply chain issues abate and supply for some of the hardest hit categories of goods catch up to current demand. The job ahead of the Federal Reserve to use their tools to help quell inflation is arguably much harder than the job they faced to stimulate the economy in the depths of the early stages of the pandemic. Inflation will be one of the most closely watched indicators for market participants in 2022.