October Outlook: ‘People Hate Inflation’

The U.S. economy continues to power through the Federal Reserve’s most aggressive tightening in decades. Unemployment is still below 4%, and stocks and home prices remain near record highs. Surprisingly, inflation is ticking up again.

The unexpected resilience of the American economy is behind the Fed’s new stance of keeping rates  “higher for longer.” While the central bank announced no change to rates at its Sept. 20 meeting, the Fed also has signaled that it doesn’t expect to begin cutting rates until well into 2024.

“We have covered a lot of ground, and the full effects of our tightening have yet to be felt,” Federal Reserve Chairman Jerome Powell said in his latest press conference.

The world’s most influential central banker has exuded calm, but he also has acknowledged that he’s far from clairvoyant. Early in this inflationary cycle, Powell downplayed rising prices as transitory. Now that he’s in full inflation-fighting mode, Powell has essentially accepted that monetary policy is a blunt instrument rather than a precise one.

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Inflation: Improving, still not tamed

The COVID pandemic, and the government’s robust response to shore up the economy with trillions of dollars in stimulus, sparked the highest inflation since the early 1980s. The Fed was caught off guard — it had feared deflation, not inflation. But by June 2022, the U.S. inflation rate topped 9%. When the inflation problem became obvious, Powell quickly changed his tune, and from early 2022 through July 2023, the Fed pushed rates from zero to 5.25%. 

As of August, the official inflation rate had increased to 3.7%, up from 3.2% in July and 3% in June. During his recent public remarks, and in spite of the recent upturn in inflation, Powell made clear that he considers inflation to be his No. 1 enemy.

“People hate inflation, hate it. And that causes people to say the economy is terrible, but at the same time they’re spending money,” Powell said Sept. 20.

Spending indeed. Writing in the Financial Times, Ruchir Sharma said the U.S. economy is staying afloat largely because of “the unsinkable consumer.”

Sharma, head of Rockefeller Capital Management, worries that the next step could be a period of stagnation. “When the stimulus and other temporary boosts wear off, the American economy could settle into a long, slow grind,” he wrote.

Powell faces a balancing act. The Fed needs to pump the brakes hard enough to slow the economy and tame inflation, but not so hard that it loses control. So far, so good, Powell reported. “We’d like the current trend to continue, which is that we’re making progress without seeing the kind of increase in unemployment that we’ve seen in past (tightening cycles),” he said.

The relationship between inflation and asset values is complicated. Inflation creates tailwinds for real estate valuations and can spur higher rents. On the downside, inflation leads to higher interest rates, which means the cost of borrowing to buy property goes up, and higher wages.

‘So much uncertainty’

The Fed’s aggressive response to inflation since early 2022 signals the end of an era of super-low rates in the U.S. To cite one example, residential mortgage rates have soared to their highest levels in more than two decades. Mortgage company Freddie Mac said that, as of Sept. 21, mortgage rates averaged 7.19%, near their highest point since 2001. 

Meanwhile, Powell noted many wild cards could disrupt markets. The United Auto Workers went on strike in September. Republican lawmakers in Congress were wielding a government shutdown as a bargaining chip. Many Americans will be compelled to resume making student loan payments soon. Oil prices have begun to trend up again. And the Fed’s response to inflation means borrowers are paying more for credit card debt, auto loans and home equity loans.

None of those issues alone is enough to derail the economic recovery. But many economists have begun to worry about the possibility of several shocks reverberating through the economy. It’s possible to imagine, for instance, that the auto strike could create another spike in auto prices, while higher oil prices and new demands for student loans could squeeze consumers already dealing with the sticker shock of sustained inflation. “There’s so much uncertainty around these things,” Powell said.