Myth of Money: Inflation Reports Predict More Doom and Gloom
Welcome to this week’s edition of Myth of Money, a weekly newsletter on the digital asset markets read by 12,000+ investors.
Disclaimer: The following is not intended as investment advice. Do your research.
Dear Investors,
The topic of conversation this week is once again inflation and interest rates.
30-year fixed mortgage rates hit 6% last week. (And that means 9% for those of you who are self-employed and looking at alternative loans, like me). My Zillow app is lit up with price-cut notifications for homes that have been on the market for 30+ days. Oh, how quickly things have changed since this time last year.
Price corrections are expected across the board, including in big cities. If you are sitting on a pile of cash, this is the time to avoid those pesky mortgages and take advantage of declining prices.
If you do have to get a high-interest mortgage on a property that costs $1M+, consider doing so for an investment property rather than a personal home, as the IRS will only let you write off the interest paid on the first $750,000 for your personal residence.
So, What’s Happening With Inflation?
The short answer is - nothing good.
CPI came back at 8.3%. This would make inflation ‘flat’ month over month, except this CPI number left out several important numbers due to “volatility.” Americans are experiencing inflation at much higher rates than the already steep 8-something percent.
For example:
Gas: +25.6%
Fuel Oil: +68.8%
Electricity: +15.8%
Groceries: +13.5%
Meat, Poultry, & Fish: +8.8%
Milk: +17%
Eggs: +39.8%
Baby Food: +12.6%
Airline Fares: +33.4%
Markets are expecting the Fed to raise interest rates by AT LEAST 0.75% this week, while traders are pricing in the possibility of a 1% increase. The Fed has raised interest rates four times this year for a total of 2.25 percentage points.
The real question is, can the Fed even get us out of this?
Sure, the Fed can raise interest rates a few more times. Housing will continue to decline (as it should frankly). But how much more do interest rates have to go up for food prices and gas prices to go down 30%? And would these raises create widespread defaults nationally and globally? A day of reckoning is coming - either because the measures have to be severe to fix inflation or because inflation will simply not be fixed.
Basically, we are screwed.
And then there is also a question of the accuracy of these numbers.
The brown line represents the month-over-month data and the blue line represents the year-over-year numbers. As seen, the July-August chart is slightly below zero and yearly data soars at an 8.3% rate.
The acute difference in direction between the monthly numbers and the yearly may pose a problem for the solution implementing government. Here are a few key points to keep in mind with regard to interest rates and inflation:
KEY TAKEAWAYS
Interest rates tend to move in the same direction as inflation but with lags because interest rates are the primary tool used by central banks to manage inflation.
In the U.S, the Federal Reserve targets an average inflation rate of 2% over time by setting a range of its benchmark federal funds rate, the interbank rate on overnight deposits.
In general, higher interest rates are a policy response to rising inflation.
Conversely, when inflation is falling and economic growth slowing, central banks may lower interest rates to stimulate the economy.
The Fed plans to continue raising interest rates in 2022 in order to curb the highest rates of inflation in 40 years.
How is Inflation Measured?
The Federal Reserve's preferred inflation measure is the Personal Consumption Expenditures (PCE) Price Index. Unlike the Consumer Price Index (CPI), which is based on a survey of consumer purchases, the PCE Price Index tracks consumer spending and prices through the business receipts used to calculate the Gross Domestic Product (GDP). This indicates that inflation isn’t mostly just one thing. A lot of macro pundits like to focus on specific components of the CPI — rent, used cars, or whatever. They do this either because it allows them to downplay the importance of inflation, or, more likely because it gives them a lot more material to write about.
Since the current inflation run began in 2020, we’ve seen a lot of manipulation of key data. At first, inflation was just lumber, then it was just used cars and computer chips. Now a lot of people are focusing on the rent number. But the median inflation numbers tell us that this micro focus is misplaced. Current inflation is not just a few items; it’s a broad-based phenomenon being driven by macroeconomic forces.
Problems With Using Interest Rates to Control Inflation
As the chart above shows, policymakers often respond to changes in economic outlook with a lag, and their policy changes, in turn, take time to affect inflation trends.
Because of these lags, policymakers have to try to anticipate future inflation trends when deciding which policy changes to implement. Yet the Fed's adherence to its inflation target can only be gauged with backward-looking inflation statistics. These can range widely amid economic shocks that can sometimes prove transitory and other times less so.
The Government’s Probable Response To The Current Inflation Crisis
Keep hiking interest rates! When headline rates started falling, some people expected the Fed to ease up a bit with a 50bp rate hike at the next meeting (scheduled for September 20th). Now, given the persistently high core CPI numbers, we are expecting 75bp or even 100bp.
According to Bloomberg, Fed Governor, Christopher Waller laid out his speculative decision tree in reaction to the interest rate
Scenario No. 1: If inflation follows the June Summary of Economic Projections: “In that case, I would support our policy rate peaking near 4%.”
Scenario No. 2: If inflation doesn’t slow or rises further: “Then in my view, the policy rate will probably need to move well above 4%,” he said, emphasizing the words “well above.”
Scenario No. 3: If inflation decelerates quickly: “Then in my mind, the policy rate might peak at less than 4%.”
The negative effect of hiking interest rates to fight inflation
Analysts have raised the following counterpoints to hiking interest rates to fight inflation:
Raising interest rates to tame demand and therefore inflation is not the right solution as high prices have been mainly driven mainly by supply chain shocks
Supply chains is a very difficult thing to manage. Therefore cost of good volatility and increasing cost of borrowing working capital can create shocks to the system, ultimately passed down to consumers.
How do we get out of this spiral? We hope that in the next 2 months, interest rate hikes have significantly curtailed demand and the high numbers we are still seeing today are simply delayed. Otherwise, more main is coming.
This Week By the Numbers 📈
Top Stories 🗞️
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SoftBank Considers Launching a Third Vision Fund
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Thank you for reading this week’s edition of the Myth of Money.🚀
Until next week,
Tatiana Koffman
By Tatiana Koffman
Hi there and thanks for reading. If you stumble upon my newsletter, you will notice that I write about money, economics, and technology. I hold a JD/MBA and spent my career in Capital Markets working across Mergers & Acquisitions, Derivatives, Venture Capital, and Cryptocurrencies. I believe in empowerment closing the financial education gap and creating equal opportunity for the next generation. I have invested in 20+ companies and funds. Check out my portfolio here.
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