November, 6, 2023 - read
The Federal Reserve Bank has two mandates: inflation and employment. Sometimes these things aren’t problems, sometimes they are very stubborn problems. The mandate for inflation requires that it be below 2%1. Headline2 CPI YOY3 reached a high of almost 9% back in June 2022. Core4 CPI YOY reached a high of 6.63% in September 2022. This is off a low of 0.12% in May 2020 for Headline CPI and 1.22% in June 2020 for Core CPI (not pictured).
The road ahead is not clear. The Fed has been raising interest rates to combat inflation. It has taken a pause this week, but the future is unclear. The market is divided over whether the pauses will continue into 2024 or whether the Fed will indeed start to cut rates. We raise this spectre to raise the issue that the rate debate “ain’t over”. It could march up or retreat down, which is a fact that is maddeningly unhelpful to any investor. Maybe the most important part is not what is going to happen but what has actually happened. The US has experienced the highest level of inflation in a long time. In spite of that, inflation has receded from its all-time high over the past few years. It is comforting to know that we are further away from the precipice regardless of whether inflation ticks up a bit again or continues its descent towards the magical value of 2%. The more perilous part of the inflation curve has come and gone; flashbacks of the 1970’s and long gas lines have receded into memory, where it belongs. We can’t say for sure what we’re in for, but it helps to say that we are further away from the regime where inflation is accompanied by “demand destruction”. “Demand destruction” is a technical phrase which indicates a regime of inflation so high that consumers stop consuming because of that very same high inflation; this is an economy killer. That regime is the stuff of “character building moments” and “cutting one’s teeth” - it is not fun.
We’ll leave it to the interest rate forecasters: those stochastic calculus experts with their 3 and 4 factor models to ponder where rates go from here. For the mere mortals among us, we ought to celebrate that the iceberg is behind us, the band can play on, and rearranging the deck chairs on the ship is a great game especially with a glass of sherry or two. We have a celebratory moment, and those do not come around often. Bask, it is OK, even therapeutic.
At Trinary Capital we recommend diversification to combat inflation. Only in the narrowest of circumstances should investors consider specialized products built as pure inflation hedges (e.g., Treasury Inflation Protected Securities and their close cousins). Popular inflation hedges such as gold or oil may work over the very long term, but this may open investors to basis risk, that is, gold and oil have other price drivers apart from inflation that might cause fluctuations.
1 The reasons for a target of 2% vary, but clearly a healthy economy necessitates nonzero inflation. It should be greater than zero but not much greater than zero. Goldilocks should be creditted.
2 What Is Headline Inflation (Reported in Consumer Price Index)? (investopedia.com)
3 Headline Consumer Price Index Year-Over-Year
4 Core Inflation Definition (investopedia.com)
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