One of the biggest concerns for Americans right now is rising inflation. Prices rose as high as 7.9% in February as compared to last year, which is the highest growth since January of 1982. There are two factors that are leading to this high inflation. The first culprit is the supply chain bottleneck issues brought about by the pandemic. Supply is simply not able to keep up with demand, especially as ports shut down and production slows due to various Covid-19 outbreaks. We also saw a huge shift in consumer behavior as people switched from spending money on services to buying goods during the pandemic. As the world shut down, consumers started buying more goods to make their lives more comfortable while staying home. This increased demand for goods, exacerbated supply shortages and led to further price increases.
Another big contributor to rising inflation is the labor market and wage growth. Because employers need to bring people back into the labor market, employees have unique leverage to demand higher pay which can cause companies to raise their prices. Unlike the supply chain issues, this is an area that could take longer to return to normal.
We are optimistic that when the supply chain issues are resolved, inflation could lower. We are already starting to see consumers shift from solely buying goods to spending money on services, which should ease the supply issues with tangible goods.
The murkier area that is causing a lot of inflationary pressure is wage growth. We don’t know what it will take to pull people back into the labor market and this is an area that may not be resolved as quickly. You may have heard in the media about the “wage-price spiral.” As workers demand more pay, companies have to charge more to source that pay, leading to a continuous cycle of consumer price increases that aren’t good for anyone in the long run.
You may ask, what happens next? This is when we see the Federal Reserve (the Fed) step in. The Fed’s goal is to keep prices stable and to keep employment as full as possible. Typically, when inflation is a threat, the Fed will try to remedy the situation by raising interest rates. And this is exactly what is happening. The Fed just announced in March that they will raise interest rates by .25% and they expect another six increases throughout the year.
Usually, when interest rates rise, the result slows down consumer spending. This probably won’t affect what you buy at the grocery store, but it may affect decisions to buy another car or other products that are paid for with interest. Rising interest rates also slow down spending by companies. They may not buy as much equipment or hire as many workers. If hiring slows down, it would take pressure off of wages and then companies wouldn’t have to increase their wages as rapidly.
In the past, like in the early 1980s, rising interest rates led to a recession. But that doesn’t mean a recession is inevitable. The Fed wants prices to stop rising so much, so they raise interest rates in order to cool down the economy—but hopefully not to the extent that we could fall into a recession. To avoid a recession, the Fed plans to raise rates slowly and, hopefully, just the right amount.
This might seem scary, but it is important to remember that the Fed is an inflation fighter and they are doing what they can to resolve this issue quickly and efficiently. As always, in times of uncertainty, it’s important to remember you are a long-term investor, and you are not alone. The Wealth Advisors at Amy Noel, Inc. are here for you, and we want to hear from you if you have any concerns or want to discuss what inflation means for you.
-Alana Macy, CFP®
LPL TN: 1-05265338