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Inflation: What's Next? Thumbnail

Inflation: What's Next?


Hi everybody, I am Mike Hengehold. 

Well, it has taken almost two generations, but after years of deficits and economic stimulus, inflation is now on a tear.  It’s chalking up its biggest gains in 40 years.  

And, with the war Russia’s war on Ukraine apparently far from over, the shortages of wheat and oil that come from that part of the world continue to put pressure on food and energy inflation. And, as we’re talking about global forces, the Chinese COVID shutdowns, which have been renewed recently, are slowing shipments of products manufactured there.  All this exacerbates supply chain bottlenecks while consumer demand continues to rage.  And of course, that is the classic definition of inflation with too much money chasing too few goods. 

The latest CPI report, which is on the screen now, shows costs are hitting consumers pretty hard, up 8.5% over the last year. You can see from the chart that prices have been rising steadily for the last three-quarters of a year or so.  

And, in addition to Consumer Prices, Producer Price inflation, which is the inflation that feeds into the manufacturing process and then spills into consumer prices is also running hot. That means consumer prices will likely remain elevated in the intermediate term, as these production costs make their way through the system. 

This next chart shows the breakdown of CPI components and where most of the pain is showing up. 

You can see that prices are rising on everything from energy to food to housing, costing the average American family about $325 per month. Now, if there’s a silver lining in this dark cloud, it’s that some of the categories, like used cars, the one with the second biggest gain there, actually saw a bit of a reversal in the most recent reporting period. This is leading some analysts to conclude that maybe the growth rate of inflation is topping out.  

One of the things I want everybody to know is, when it comes to inflation and the financial planning that we do for retirement, is that we build inflation assumptions into each of the retirement plans we design.  So, when inflation does surface, you are prepared. 

And, I want to remind everybody that a little inflation is actually good. In fact, In the U.S. our Federal Reserve targets an inflation goal is about 2%.  But, as you can imagine, when inflation gets too high, and it gets out of hand, as it is now, it can cause big financial problems for the economy.  So, to avoid bad outcomes, the Federal Reserve, as the official guardian of the economy, is charged with putting inflation back in the bottle.  This can be hard to do, though, because inflation can create a dangerous mindset. 

This happens when workers and companies see prices going up, and they react by demanding higher wages and higher prices for their products. Suddenly, inflation becomes a self-fulfilling prophecy.  And, kind of like a wildfire, continues to spread pretty quickly. 

These cycles can be tough to stop. So, the Fed may be forced to inflict some financial pain on investors to accomplish their goal of taming inflation. This is one of the important points I wanted to make, as this is something to be prepared for.  

The Fed essentially tamps down on the wealth effect by deflating the stock market, and if people aren’t feeling as wealthy they tend not to spend as much, and now we’re starting to reverse that problem of too much money chasing too few goods, because it’s another way of draining money from the system.  

The Fed’s current belief is that they can bring inflation under control later this year though policy adjustments, which generally involve adjusting interest rates and money supply, while at the same time market forces sort out supply and demand imbalances.   

I would tell you how this is going to work out, but unfortunately, and long-term clients understand my problem here, my crystal ball is in the shop waiting for parts.  I can only assume this involves more supply chain issues.  I don’t know for sure.  

Anyway, history is not on the Fed’s side here. Being able to engineer a soft landing is difficult and typically not something they successfully pull off.  But hey, there is a first time for everything, right?  We have our doubts, and that is evidenced by the fact that we have a defensive posture that we’re starting to build into our tactical Advance and Defend portfolios. 

That’s it for today. Let us know if you have questions, and thanks for watching. 

Mike Hengehold Headshot Mike Hengehold, CPA/PFS MST RICP®
Mike is the Founder and President of HCM Wealth Advisors. Over the last 30 years, he’s provided financial planning guidance to a myriad of families to help them realize their financial dreams. Mike is an avid homebrewer and animal lover, and when he’s not at work you can often find him on the golf course working on his short game.
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