Interest Rates & Inflation

Interest Rates & Inflation

Bet you that title got you all excited?!  Nothing like a fun blog about the current interest rate and inflationary environment to kick off your Tuesday.  That said, these two items are under huge focus this year as the country/world waits to see what happens.

Where are we now?

Current interest rates have been hovering at 5.25-5.50 percent since the Fed halted its historic rate increase in 2023.  This has been done to combat hyperinflation by making the cost of capital more difficult.  In turn, the thesis is that it tightens the economy in such a way that inflation starts to subside. 

Is it working?  I suppose the best answer is yes and no.  For starters, yes, we have seen inflation come down to a much more reasonable 3.48%.  Remember the Fed targets 2% as their ideal inflation rate, despite the long-term average being closer to 3%.  This is a huge relief from the 7-plus range we saw at its peak.  This is why I say it is hard to argue that higher interest rates are and have worked.

No!  I suppose a blatant no is a bit harsh when asked if interest rates are working to combat inflation.  The issue really is the Fed is having a difficult time getting that last 1-1.5% of inflation down.  Unemployment is low, the job market is strong, earnings are strong, and by and large we are looking at a relatively strong economy. 

Are we concerned?

I’d say we are cautious but certainly not concerned.  For all the reasons mentioned above are economy is quite strong right now.  Additionally, this isn’t a huge surprise to us.  Many of the Fed’s policies take time to work their way through the markets and economy.  We also didn’t expect things to come crashing straight down.  In a way, this is kinda sorta the path one would have expected.

If we look at the big picture, we have seemingly avoided the “hard landing” we all once feared.  Things are settling down nicely and, more or less, have to get over this last hump of elevated inflation.

Where do we go from here?

Well, it seems pretty clear that the Fed isn’t going to be rushing to lower their interest rates, at least not as quickly as we hoped.  Going into this year we thought 3-4 decreases were basically penciled in.  Now most economists are changing their tune to hopefully 2 decreases if we are lucky, and not until the second half of the year at best.

Really the Fed is taking in data every day and at every meeting discussing this data.  Their biggest concern is they prematurely lower rates and must reverse course.  This to them is their doomsday scenario.  Instead, they would much rather keep rates elevated a bit longer and exercise a bit of caution, and this is exactly what they are communicating to the public.

There are even some talks that maybe inflation will settle around 3% and that will be the new 2% in this day and age.  Candidly, no one knows what the future will hold, not even the Fed.  Things will continue to be hot and cold, with a myriad of data to sift through. 

What do higher rates for longer mean?

Finally, so what, why should you care?  There are a few reasons you should care about higher inflation and interest rates. 

1. Simply put, the cost of goods remains higher than we want.  This means we can’t save as much or spend as much as we’d like as everyday goods are consuming more of our income.
2. Borrowing will be tougher.  This hits basically everyone.  For individuals, mortgage rates remain higher and basically, the cost of capital is more expensive.  This means you can basically afford less.  For businesses, this holds true as well.  They will make fewer big purchases, or acquisitions, thus potentially slowing their growth prospects.  Additionally, if you are valuing a business on its free cash flow, they now have less of it than they once did as more of their revenue must go to debt servicing.
3. The markets the markets the markets.  The bond markets may rejoice while the stock market may not.  This is all conjecture to some degree, but higher rates aren’t as advantageous to stocks and are quite ideal for bonds.  That said a well-diversified portfolio may have you as best prepared for whatever comes next as possible.

Soooooo?

So what next?  There are always tactical changes to be made in portfolios given any environment or data.  We are certainly keeping an eye on it all plus much more for our clients.  We predict things will consistently be inconsistent for the next bunch of months while inflation continues to subdue.  In the meantime, stay on the course and trust that your long-term plan is appropriately set up to weather whatever comes next.

As always stay wealthy, healthy, and happy.