05/19/2022
Read this post for more information about inflation and the US dollar. Be sure to join us on May 19 for this week’s Lunch & Learn to learn about inflation from one of our key investment partners. Click here to RSVP.
Inflation defies tradition
A recent headline in the Wall Street Journal summarizes a unique historical aberration: Years ago, high U.S. inflation meant a weak dollar. So far, it is different this time, and many on Wall Street are betting it will stay that way.
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This defies tradition, and possibly common sense. Inflation can be defined as the gradual loss of purchasing power. Every year, everything we buy gets more and more expensive. And so, the flipside of that statement also seems true: the dollar is losing purchasing power.
But today, the dollar is stronger relative to other currencies at the same time that we have decades-high levels of inflation. How can that be?
Inflation is relative
Inflation is worse for other currencies than it is for the US dollar. In this same WSJ article, the author interviews a number of experts, including a person who is the “head of inflation trading.” They prognosticate about the future of currencies and interest rates and explain their rationale. I don’t recommend reading it.
In the real world, the right way to invest is to diversify by strategy. Some of the experts will be right, and some of them will be wrong. We will never know in advance who is right or wrong.
In the real world, the traditional definition of inflation will eventually be true. Even if in this short, strange and scary moment, the dollar is both gaining and losing, we don’t benefit a whole lot. We are buying our groceries with greenbacks, and we notice the higher prices.
Interest rates will keep rising, but for how long and how far?
The end-game for inflation may be determined by interest rates. If the Federal Reserve continues to raise rates then eventually inflation will succumb. That is the theory. It was last tested when Paul Volcker was the Fed Chairman under Presidents Carter and Reagan. It worked 40 years ago. The Fed is betting it will work again today.
Humans are fallible. People fear the Fed will over-shoot and cause a recession. It seems likely that the autocracy will err, but that does not mean a recession. The world is uncomfortably more complicated than the news media may have us believe. I believe many other factors—most importantly how many of us are working—matter more than inflation.
In the real world, if a working-age person cannot find work, inflation doesn’t matter. And today, the opposite is true. Employers cannot find workers. The employment rate is very good. This fends off the hounds of recession. This, among other things, gives the Fed confidence to continue to raise rates.
Rising rates are hard on bonds and other fixed income investments. And yet, if rates are high enough, then perhaps we can see a bright light of reasonable fixed income returns. After interest rates rise to a certain level, then we have more certainty.
In the meantime, the investment road could be rough. Don’t look, instead call your financial planner. Let’s hope for a short transition from this zero-or-negative interest rate world into that traditional world, where fixed income investments may pay something, and equities, as they always have before, may deliver long-term, real-life positive returns.
