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Jeffrey P. DeHaan, CFP®

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Inflation on All Fronts

John Sleeting March 01, 2022

Inflation is a monetary phenomenon and in the short term can be affected by supply/demand dynamics.  The Investment Policy Committee of Clearwater Capital has written extensively about the dramatic rise in the M-2 Money Supply over the last two years emanating from fiscal spending which ‘flooded the world with cash’ following the COVID shutdown of the economy.  We are not debating the merits of the policy, but have been highlighting the affects of fiscal spending and the monetization of U.S. Debt through the Central Bank.

The Federal Reserve Bank (The Fed) has a dual mandate – full employment & stable prices.  Put simply, keep interest rates low to drive full employment and keep interest rates high to slow inflation.  The Fed has taken emergency actions to bring the Fed Funds Rate to effectively zero over the last two years in favor of full employment.  Low policy rates have led to borrowing and thereby further expanding cash in circulation leading to inflationary pressure.

The Federal Reserve has a target of roughly a 2.0% inflation rate, but the latest reading from the U.S. Bureau of Labor Statistics on February 16, 2022, reads, “Consumer prices up 7.5 percent over year ended January 2022”.  It’s no surprise to anyone that inflation is hitting all segments of society.  So, the question is not IF the Fed will raise rates, but when and by how much.

Geopolitical implications for Fed Policy and Inflation are two-fold:  First, raising rates in the face of Russia’s aggression into Ukraine while Russia threatens the world over intervention seems to be a political challenge for the Fed.  ‘What If?’ scenarios circulating everywhere would lead the Fed to potentially demonstrate caution in raising rates too quickly.  Afterall, if they raise rates only to have a global slowdown, that is problematic.

The flipside is, if the Fed is slower to raise rates and allow inflation to run higher, that is evidence of a strong economy in light of war in Ukraine.  We believe they will take the latter approach and be incremental in their steps, right or wrong.  This approach is currently reflected in the Futures Markets, where the probability of only one increase in the Fed Funds Rate to 0.25%-0.50% (from currently 0.00%-0.25%) is currently (2/28/2022) just over a 90% probability and illustrates a step in the direction without over-stepping or moving to fast too soon.

Source: CME Group

Second, geopolitical supply/demand affects will increase upward price pressures.  We can see in the Consumer Price Index (CPI) from the Bureau of Labor Statistics that Energy is already a significant contributor to inflation; and, we expect it will only become more strained given sanctions and the reduction of oil & gas supply from Russia.

Therefore, if the Federal Reserve Bank moves more slowly (thereby allowing inflation to run higher) plus our belief that energy prices will increase costs of everything requiring transportation, the anticipated result is inflation continuing at a ‘higher than normal’ level for the foreseeable future.

John Sleeting

disclosure

THIS COMMENTARY HAS BEEN PREPARED BY CLEARWATER CAPITAL PARTNERS. THE OPINIONS VOICED IN THIS MATERIAL ARE FOR GENERAL INFORMATION ONLY AND ARE NOT INTENDED TO PROVIDE OR BE CONSTRUED AS PROVIDING LEGAL, ACCOUNTING, OR SPECIFIC INVESTMENT ADVICE OR RECOMMENDATIONS FOR ANY INDIVIDUAL. ALL ECONOMIC DATA IS DERIVED FROM PUBLIC SOURCES BELIEVED TO BE RELIABLE. TO DETERMINE WHICH INVESTMENTS MAY BE APPROPRIATE FOR YOU, PLEASE CONSULT WITH US PRIOR TO INVESTING. INVESTING INVOLVES RISK WHICH MAY INCLUDE LOSS OF PRINCIPAL.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities, insurance products, or to adopt any investment strategy. The opinions expressed are as of the date of writing and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by Clearwater Capital Partners to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. International investing involves additional risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. Index performance is shown for illustrative purposes only. You cannot invest directly in an index. S&P 500 is a registered trademark of Standard & Poor’s Financial Services, a division of S&P Global (“S&P”)  DOW JONES, DJ, DJIA and DOW JONES INDUSTRIAL AVERAGE are registered trademarks of Dow Jones Trademark Holdings (“Dow Jones”). The two main risks related to fixed-income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments.

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