By Scott Poore, AIF, AWMA, APMA
Chief Investment Officer, Eudaimonia Group
Much is being made lately of the Ukraine Crisis being responsible for the rise in inflation and laying the blame at the foot of Russian President Putin. However, if we track the speed of money, it allows a better clue of why inflation has been rising for nearly 2 years. Steve Miller famously wrote the song "Take the Money And Run" about a Bonnie-and-Clyde romance/theft story. The song entered the Billboard To 100 Chart on May 2nd, 1976 and peaked at #11 on July 18th of that year. Given the trillions of dollars in economic stimulus that was handed out in the pandemic, the song has meaning for us in today's economic environment.
Bobbie Sue, whoa, whoa, she slipped away.
Billy Joe caught up to her the very next day.
They got the money, hey, You know they got away.
They headed down south and they're still running today,
Singin' go on take the money and run!
Where Did All of This Inflation Originate? Well, it ain't Putin and it ain't COVID, per se. Any basic search on the internet will bring up hundreds of articles about various forms of fraud related to the money that was handed out during the pandemic. One man in California has been convicted of fraud as he submitted 27 PPP loan applications illegally, obtaining more than $3 million in PPP funds. According to one source, 1.8 million of the 11.8 million PPP loans submitted showed signs of fraud and nearly $76 billion in PPP loan money of the $800 billion issued was taken unlawfully. This plus the Fed purchasing assets and expanding their balance sheet from roughly $4 trillion to $9 trillion and the multiple relief packages passed by the government totaling nearly $6 trillion in stimulus are what has been the primary drivers of inflation. People were laid off when the economy shut down, but people were also strong savers, as no one knew for sure what the future held in store. When you attempt to shut down something as large as the U.S. economy ($21 trillion) at the beginning of the pandemic, you can't just restart it with the flip of a switch.
Fast forward to today and we can see the ramifications of bad policies across the board. Both the previous administration and the current administration implemented policies that were harmful and that led to hyper-inflation and yet, no one is willing to admit it. The supply chain, which was forced to scale back significantly during the first few weeks of the pandemic (remember the empty shelves and lack of toilet paper) was subsequently forced to get back to full strength just a few short months after the pandemic began. This is not something that can occur overnight. Inflation, despite what the current administration wants people to believe, began rising almost immediately after the Fed began asset purchases and the 1st stimulus package was passed. It began skyrocketing higher when the final stimulus package was passed in March of last year. Until we see input costs (Producer Price Index) shrink, we're not likely to see consumer costs (Consumer Price Index) decline anytime soon.
Actions Have Consequences. I wonder what policymakers thought would happen when you shut down an economy, flood it full of money, then try to turn everything back on? Clearly, economists were not seeing things clearly. In July of 2020, most economists were not expecting trillions of dollars in economic stimulus to create inflation - that was the headline, at least. And yet, that's exactly what happened. For months and months the Fed tried to convince everyone that things were A-ok. I thought it helpful to go back and look at previous posts to see if I was seeing things different. In a Market Musings post in December of 2020 I noted, "We believe the Fed will struggle next year with inflation as they try to keep the Fed Funds Rate low with high unemployment through the first two quarters of next year.” At least I didn't turn out to be crazy based on that little nugget.
Now that we know that the Fed is behind the curve on inflation, Fed governors have been outspoken this week about larger-than-expected rate hikes. In fact, that market is beginning to price in a 75 basis point hike as St. Louis governor Bullard hinted to this week. The market was moving higher rather nicely until the Fed decided they needed to be outspokenly hawkish. For the first time, implied futures on the next Fed meeting in May now show a 2% probability of a 75 basis point rate hike. While the 10-year Treasury yield is down today, the 2-year Treasury yield is up on the recent Fed comments. It's unclear if the Fed is now speaking so hawkish as to cool markets or if their intention is to actually raise rates 75 basis points at the next meeting. What is clear is that investors, who haven't faced this much of an increase in inflation and interest rates at the same time in over 40 years are finding it difficult to cope.
What Are Investors To Do? The best advice is not to panic. Overall, there is little evidence of a recession on the immediate horizon. The economic data released this week has been on par with previous weeks - mixed. Building Permits and Housing Starts were both higher than expected and higher month-over-month. Continued Claims dropped, while Initial Jobless Claims were more than expected but lower month-over-month. The Fed's Beige Book showed "moderate economic growth" and the Redbook Sales (YoY) were higher (displaying the strength of the U.S. consumer). The Fed's own measurements of economic stability are evident when we move back to see the "forest for the trees." The St. Louis Fed's "Financial Stress Index" is near all-time lows. As a refresher, when that index is below zero, that means that there is very little stress in the U.S. financial system. Right now, that index is -1.22. The Chicago Fed's "National Financial Conditions Index" is showing loose financial conditions. Similar to the Financial Stress Index, when the NFCI is below zero that means there is less stress in the system. Right now the NFCI is -0.38. So, the best course of action right now is to stick to your financial plan and investment strategy. There may be some volatility ahead, but making dramatic changes to your overall investment portfolio at this stage is unnecessary.