Inflation Fueled by Expectations
An extraordinary combination of shocks has created the worst inflation in four decades. The pandemic initially disrupted supply chains and employment relationships. Aggressive stimulus spurred more demand that further aggravated the bottlenecks when economies reopened. And this spring, the war in Ukraine sent energy, food, and commodity prices soaring. Even worse, Fed Chair Powell has warned that sky high inflation could become permanent.
The Fed’s aggressive interest rate hikes are driven in part by the fear that consumers and businesses will expect high inflation to continue. The expectation of soaring inflation can create a vicious self-fulfilling prophecy. Higher expected inflation can lead businesses to raise prices at a faster pace. And if consumers expect prices to be higher next year, they will buy now. In turn, workers demand bigger raises. All in all, this kickstarts a self-perpetuating cycle of persistently higher inflation.
People are right to expect inflation to go even higher. Inflation is soaring at its fastest pace since 1981. It hasn’t started to cool off despite multiple interest rate hikes. Experts agree. Inflationary pressures are likely to get worse, according to HSBC’s global chief strategist Joe Little. He said that the era of historically low inflation and interest rates was over.
Dave Pierce, director at Utah-based Strategic Initiatives, told CNBC that inflation had not yet peaked. “I can’t see how we can stop the inflation that we have going on,” he said.1
The window to cool inflation before it becomes permanently high is closing. Already, analysts estimate that the benchmark rate would have to go up to 9% to counter people’s expectations.2 “There’s a clock running here, where we have high inflation running now for more than a year and it would be bad risk management to just assume that those longer-term inflation expectations will remain anchored,” Powell said.3
Rampant inflation became entrenched in the 1970s after high inflation expectations took hold. It was only broken with cripplingly high interest rates. Taming inflation came at a heavy cost. A series of recessions followed with the highest unemployment rates since the Great Depression.
Powell’s outlook is now a world away from the inflation is ‘transitory’ view he shared just a year ago. The central bank no longer assumes the supply chain will heal itself. The Fed’s aggressive rate hikes support their new hawkish view. In June, policymakers approved the first .75 percentage point increase since 1994.
Uncertainty around what the post-pandemic economy will look like leaves the central bank with little precedent for setting policy. Powell said that’s played a significant role in letting inflation reach such dizzying heights. He says the global economy is now “driven by very different forces” than it was just three years ago. According to him, the ways to reduce inflation from past decades could possibly be gone for good. “I think we now understand better how little we understand on inflation,” Powell said Wednesday.4
Powell also acknowledged that the large interest rate hikes increase the chances of a recession. “Is there a risk that we would go too far? Certainly there’s a risk, but I wouldn’t agree that’s the biggest risk to the economy,” Mr. Powell said. “The biggest mistake to make…would be to fail to restore price stability.” 5
The Fed is gambling that stopping inflation with a recession now is better than a having to face an even worse recession in the future. As they roll dice with the economy, stocks are dropping, and retirement funds are getting wiped out. Safe haven assets are a greater priority than ever before. If you want to protect your funds, contact American Hartford Gold about a Gold IRA today.