September 8, 2023
It was a challenging month across markets. Signs of moderating inflation along with still robust economic conditions were offset by an increase in interest rates and concerns that the Fed could keep interest rates higher for longer than may be currently priced into markets. Expectations for an economic “soft landing” appear to be a growing consensus, but the substantial monetary tightening of the past two years and the Fed’s assessment that inflation remains too high, has kept uncertainty high.
There was no Fed meeting in August, and thus no policy changes to short-term interest rates, but yields for longer-dated treasuries increased during the month. Still, at the annual conference in Jackson Hole, Fed Chairman Powell reiterated that the job to bring down inflation was not yet over: “We are prepared to raise rates further if appropriate, and intend to hold policy at a restrictive level until we are confident that inflation is moving sustainably down toward our objective”.13
Economist Milton Friedman famously said that inflation “is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”17 He was specifically referring to “persistent” inflation rather than supply shocks that may drive prices higher temporarily. The chart below shows a broad measure of the “quantity of money” for the U.S. The sharp rise in this M2 gauge of the money supply in the early months of the pandemic is easy to see. Of course, that surge was designed to rapidly and substantially address the dramatic drop in the supply of goods when the global economy shut down in the first months of the Covid pandemic.
The jump in the supply of money offsetting a temporary smaller supply of goods would not necessarily have created persistent inflation, but critics of the Fed would instead point to the continued above pre-pandemic trend growth in M2 in the months after May 2020 as a large reason why inflation rose to such elevated levels in 2022 and is now requiring aggressive tightening efforts by the Fed to bring down. These efforts certainly increase the risk of recession.
Just as increases in the money supply can fuel inflation, reductions can serve to lower demand and prices. The impact is not immediate, however. The substantial declines in M2 that began in the spring and summer of last year have indeed begun to impact inflation. The chart below shows the year-over-year change in inflation for the Personal Consumption Expenditures index, the Fed’s preferred measure of inflation when removing the volatile food and energy components. Much of the recent rise and fall in inflation comes from those volatile commodities, especially energy prices.
The headline inflation numbers (those that do not exclude food and energy) have been cut in half from the peak in June 2022. That feels like substantial progress, but there’s still another halving of inflation needed to bring the rate down to the Fed’s target of 2%. The picture is less encouraging when removing food and energy prices, with the Core PCE still 2.5 times higher than the Fed’s goal. The debate among investors and also within the Fed is whether there has already been enough tightening to bring these inflation numbers down to the target or if the Fed will have to restrict policy and raise rates further to finish the job. It’s a difficult question to answer given the imprecise nature of how monetary policy impacts inflation and the economy. The markets seem to have priced in no more rate hikes from the Fed as well as a soft landing for the economy so any changes in that trajectory would almost certainly drag down prices for both stocks and bonds.
17 Friedman, Milton. 1970. Counter-Revolution in Monetary Theory. Wincott Memorial Lecture, Institute of Economic Affairs, Occasional paper 33.
Disclaimer: The views expressed in this material are the views of Atomi Financial Group, Inc. dba Alternativ Wealth through the period ended August 1, 2023 and are subject to change based on market and other conditions.
This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
All information is from Alternativ Wealth unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
Alternativ Wealth is not, by means of this publication, rendering legal, tax, accounting, consulting, securities, real estate or other professional advice or services, and this publication should not be used as a basis for any investment decision or as a substitute for consultation with professional advisors. Alternativ Wealth shall not be held responsible for any loss sustained by any person that relies on information contained in this publication.
This publication and the information contained herein is intended to offer general information and is not to be construed as a recommendation to make any decision concerning the purchase or sale of securities, insurance products, real estate, accounting and or legal services. Such offers are made only by prospectus, contract, or engagement agreement. A prospectus or contract should be read thoroughly and understood before investing or sending money. Investments involve risk. Investment return and principal value will fluctuate, so that your investment, when redeemed, may be worth more or less than its original cost. Past performance is not a guarantee of future results. All such decisions should be based on the consideration of specific objectives, relevant facts, pertinent issues and particular circumstances, and should involve appropriate professional advisors.