Tag Archives: Inflation

Extraordinary Fiscal Spending a Threat to Economy

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Jamie Dimon, Chairman and CEO of JP Morgan Chase, says “government fiscal spending has been “so extraordinary” in the past five years he’s bracing for an economy of high inflation and unemployment.”

Dimon expressed concern that unchecked government spending could lead to stagflation – a dreaded combination of high inflation, high unemployment, and low growth1.

Dimon’s perspective is rooted in the massive fiscal and monetary stimulus that has occurred over the last five years. He questions whether this unprecedented level of intervention will eventually result in stagflation. He also believes that inflation may be stickier than many people assume, given the lingering effects of fiscal and monetary stimulus in the system.

In summary, Dimon’s cautionary stance underscores the need for prudent fiscal policies and a careful balance between economic stimulus and potential consequences.

Source:  https://fortune.com/2024/05/29/jamie-dimon-stagflation-fiscal-monetary-stimulus-government-spending-american-economy/

Inflation and Investments

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Inflation is an economy-wide, sustained trend of increasing prices of goods and services, and loss of dollar purchasing power from one year to the next. It affects investments in several ways:

Real Value Erosion:

The rate of inflation represents how quickly investments lose their real value and how quickly prices increase over time.

As prices rise, the purchasing power of money decreases. For example, if you can buy a burger for $2 this year and the yearly inflation rate is 10%, next year the same burger will cost $2.20.

To maintain your standard of living, your investments need to generate returns equal to or greater than inflation.

Investment Returns and Inflation:

If your investment returns do not outpace inflation, your real returns (adjusted for inflation) may be negative.

Suppose ABC stock returned 4% and inflation was 5%. The real return on investment would be minus 1% (5% – 4%).

Asset Classes and Inflation:

Liquid assets (e.g., cash, short-term deposits) tend to appreciate more slowly than other assets. They are more vulnerable to the negative impact of inflation.

Illiquid assets (e.g., real estate, long-term investments) are also affected by inflation but may appreciate in value or generate interest, providing a natural defense.

In summary, understanding inflation is crucial for making informed investment decisions. Consider investments that can keep pace with or exceed inflation to protect your purchasing power over time.

Persistent Inflation and Loss of Purchasing Power

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U.S. Consumer Price Index (CPI) data was hotter than expected.

March 2024 U.S.CPI annual inflation rose 3.5%, above expectations of 3.4%.

Core CPI inflation increased 3.8% year-over-year (Y/Y), compared to forecasts for a gain of 3.7%.

The March 2024 Consumer Price Index for All Urban Consumers (CPI-U) report marked a third consecutive 0.4% month-over-month (MoM) increase. On a year-over-year (YoY) basis, inflation rose by a stronger-than-expected 3.5% in March

  • The slightly stronger March Consumer Price Index (CPI) report was driven by rises in shelter and energy prices.
  • March’s stronger year-over-year (YoY) rise in the headline CPI suggests the path to the Fed’s 2% target could take longer than expected.

Persistent Inflation occurs when the U.S. money supply grows more rapidly (to pay for huge fiscal deficits) than the country’s economic output.

Money Supply and Inflation:

When the Federal Reserve (the Fed) increases the money supply, it leads to inflation.

Imagine an economy with $100 and 100 bananas. If the government increases the money supply by 10% to $110, but the banana output only grows by 5% to 105 bananas, we have more money chasing fewer goods. As a result, the average price per banana increases from $1 to roughly $1.05. Thus, the purchasing power of the currency is reduced.

The quantity theory of money (QTM) suggests that the value of money is determined by supply and demand. When the money supply grows faster than economic output, inflation occurs.

Monetarist View:

Monetarists believe that inflation results from too many dollars chasing too few goods. As the money supply grows, the value of money decreases due to supply and demand dynamics.

In summary, managing the money supply is imperative for the Fed. Too much growth can lead to persistent inflation, affecting the purchasing power of the dollar.

2024 Personal Consumption Expenditures for February

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The personal consumption expenditures (PCE) price index, the Federal Reserve’s preferred way to measure inflation, rose 0.3 percent in February, while the annual inflation rate rose to 2.4 percent in February, up 0.1 percentage points from January. The number excluding volatile food and energy prices rose 0.3% on a month-to-month basis, slightly faster than anticipated.

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Federal Reserve Chair Jerome Powell indicated the latest PCE report did not undermine the central bank’s baseline outlook, but said with the economy on a “strong” footing, “that means we don’t need to be in a hurry to cut.”

Some details of the PCE data for February, economists noted, showed improvement in aspects of inflation that the Fed considers important, even as the headline numbers have shown little progress in the first two months of the year.

The central bank last week held its benchmark overnight interest rate steady in the 5.25%-5.50% range and also reaffirmed – narrowly – a baseline projection that the rate will fall by three-quarters of a percentage point by the end of 2024.

Source: Howard Schneider and Ann Saphir, New US inflation data ‘along the lines’ of what Fed wants, Powell says, Reuters, March 29, 2024. https://stocks.apple.com/A8OnyemvKT4ue7DzP7DFCdg

U.S. Money Supply Drives Inflation

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“Inflation is always and everywhere a monetary phenomenon.” – Milton Friedman

Economist Steve Hanke view has been that the volatile and non-transitory inflation of recent years is chiefly due to changes (a significant increase) in the US money supply, not other factors such as supply-chain disruptions and swings in energy and metal prices.

Hanke, a former economic advisor to Ronald Reagan, served as the president of Toronto Trust Argentina when it was the world’s best-performing market mutual fund in 1995.

“As Milton Friedman taught us long ago, inflation is always and everywhere a monetary phenomenon,” Hanke said. “That’s why our forecast, based off the quantity theory of money, has been so accurate.”

“Inflation is taxation without representation.” ~ Milton Friedman

The veteran economist Hanke and a colleague, John Greenwood, predicted in July 2021 that the headline Consumer Price Index would rise as quickly as 9% on an annualized basis; it peaked at 9.1% a year later. They later forecast the inflation measure would fall to between 2% and 5% by December last year, and it ended the year at 3.4%.

“Money [supply] is the economy’s fuel,” Hanke and Greenwood warned the US economy was “running on fumes” and “on schedule to tank” given its money supply had contracted since March 2022, after growing by a historic 27% in part due to fiscal stimulus measures during the COVID-19 pandemic.

References:

  1. https://markets.businessinsider.com/news/stocks/steve-hanke-stocks-economy-outlook-recession-inflation-forecast-fed-money-2024-1

Stocks Beat Bonds as Inflation Hedge

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“Stocks are great long-term inflation hedges if you are still worried about inflationary risks.” ~ Jeremy Siegel, Wharton School Economist

“If you are worried about the inflationary impacts, stocks are far better hedges than bonds — as companies can pass along their own input cost spikes to consumers,”Jeremy Siegel, Wharton School Economist, wrote in his weekly commentary published Monday for WisdomTree, where he is senior economist.

“If you bought the inflation-hedged bonds at 2% yields, it would take 36 years to double your purchasing power,” wrote Siegel, an emeritus professor at The Wharton School. “The S&P 500, however, is priced around 18 times next year’s earnings, giving a 5.5% earnings yield. This takes just 13 years to double purchasing power.”

“Stocks at the present time—with earnings of just under $250 for the S&P 500,” are preferred states Siegel. “This giving just under an 18x earnings per share valued market. I think that is a favorable multiple for the market. I believe stocks are great long-term inflation hedges if you are still worried about inflationary risks. I think stocks can handle another quarter point rise by the Fed if they deem it necessary.”

References:

  1. https://www.thinkadvisor.com/2023/09/28/jeremy-siegel-stocks-beating-bonds-as-inflation-hedge/
  2. https://www.wisdomtree.eu/-/media/us-media-files/documents/resource-library/weekly-commentary/siegel-weekly-commentary.pdf

April’s Consumer Price Index and Inflation

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CPI year-over-year inflation 4.9% as the economy showed signs of cooling 

Consumer prices in the U.S. rose 0.4% from March to April, up from 0.1% from February to March. Compared with a year earlier, prices climbed 4.9%, down just slightly from March’s year-over-year increase.

The nation’s inflation rate has steadily cooled since peaking at 9.1% last June but remains far above the Federal Reserve’s 2% target rate.

The Fed is paying particular attention to core prices, which exclude volatile food and energy costs and are regarded as a better gauge of longer-term inflation trends.

The Federal Reserve aggressively raised rates for more than a year to try to tame inflation by slowing economic activity, and indicated last week it might be done lifting them for now.

Core prices rose 0.4% from March to April, the same as from February to March. It was the fifth straight month that core prices have risen by 0.4% or more. Increases at that pace are far above the Fed’s 2% target.

Compared with a year ago, core prices rose 5.5%, just below a yearly increase of 5.6% in March.

Unlike the prices for products, the costs of services — from restaurant meals to auto insurance, dental care to education — are still surging. A major reason is that companies have had to raise pay in those industries to find and retain workers.

Federal Reserve officials say that fast-rising wages, while good for workers take home income, have contributed to higher costs in services industries because labor makes up a significant portion of there costs.

Bank Bailouts

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“Bailouts incentivize and encourage the financial behavior that makes bailouts necessary.” ~ Holman W. Jenkins, Jr.

The fundamental business model of banking is that the bank accepts money from bank depositors and invest almost all of it. A certain amount of depositors’ money, called reserve requirement, must be kept for redeeming customer accounts and customer withdraws. The remaining deposits gets loaned out, often in long-term illiquid loans  and assets.

If customers want to withdraw amounts greater then the reserves, typically refer to as “ run on a bank”, a bank has two options:

  • Raise money by selling investments at a profit or loss
  • Raise enough money to bridge its cash needs by selling equity in the bank itself hurting shareholders.

Going forward, your bank deposits are implicitly safe from bank failures, but your bank deposits aren’t safe from inflation due to lost of purchasing power, writes Holman W.Jenkins in  WSJ Opinion piece. In essence, the investment risks that large sophisticated uninsured depositors take were shifted to bank shareholders and U.S. taxpayers by the federal government.

Effectively, the FDIC $250K bank deposit insurance limit guarantee is now uncapped. By implicitly guaranteeing all bank deposits, the government’s policy will actually incentivized banks to take even more riskier investment bets with depositers’ cash to garner outsize returns. In short, uninsured deposits were a source of market deposits discipline.

Moral hazard refers to the situation that arises when an individual or bank have the chance to take advantage of a financial deal or situation, knowing that all the risks and fallout will land on another party. It means that one party is open to the option – and therefore the temptation – of taking advantage of another party.

Moral Hazard

In this case, the secondary party, the tax payers, are the ones that suffers all the consequences of any financial risks taken in a moral hazard situation, leaving the first party free to do as they please, without fear of responsibility. They are able to ignore all moral implications and act in a way that is most beneficial to them.

The government’s actions to implicitly guarantee bank deposits does not actually eliminate the risks of additional bank runs or failures, it only transfers the risk and subsequent obligations to the FDIC and ultimately the U.S. taxpayers. It also encourages financial moral hazard, the taking of extraordinary investment risk with bank assets, by bank chief executives.

Source: Holman W. Jenkins, Jr., “Joe Biden’s $19 Trillion Monday”, The Wall Street Journal, March 15, 2023

Hot PPI in January 2023

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Inflation at the wholesale level, measured by the Producer Price Index (PPI), rose more than expected in January 2023. 

The U.S. Labor Department reported that its producer price index, which measures inflation at the wholesale level before it reaches consumers, came in hotter than expected and rose 0.7% in January from the previous month. On an annual basis, prices are up 6%. In short, PPI is reflects intrinsically the prices consumers will be paying for goods and services in the near future.

Those figures were both higher than the 5.4% headline figure and 0.4% monthly increase in forecast by Refinitiv economists, a worrisome sign for the hawkish Federal Reserve as it seeks to cool inflationary price gains and tame consumer demand with the most aggressive interest rate hike campaign since the 1980s.

Excluding food and energy, core inflation increased 0.1% for the month – matching the estimate from economists.

Stubborn inflation has caused more Americans to live paycheck to paycheck despite 5.1% increase in wages, reports Fox Business. Increased wages are not keeping pace with soaring prices of consumer goods and services, prompting many Americans to live paycheck to paycheck.

References:

  1. https://www.foxbusiness.com/economy/wholesale-inflation-surges-january-more-expected-high-prices-persist

January 2023 CPI Inflation Grew at 6.4% annual rate

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January 2023 consumer price index (CPI) report showed that inflation grew at a 6.4% annual rate, slightly higher than expected, reports CNBC.

Stubbornly high January inflation reading and the December CPI report was revised to show a slight gain instead of a decline was largely better than feared, but at the same time unlikely to cause the Fed to back off from its tightening campaign.

“While there were no major surprises in today’s CPI reading, it is a reminder that while inflation has peaked it could be a while before we see it moderate to normal levels,” said Mike Loewengart, head of model portfolio construction at Morgan Stanley Global Investment office.

“The question remains if inflation will be able to fall to the Fed’s target levels with the labor market as tight as it currently is,” he added. “That could be the recipe for a soft landing, but it remains to be seen when the Fed will shift away from rate hikes and if the labor market will lose its resiliency.”

References:

  1. https://www.cnbc.com/2023/02/13/stock-market-today-live-updates.html

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