Broker Check

Rising Inflation Should Dissipate

February 11, 2022
Share |

  • A recent inflation report showed consumer prices rose at the fastest rate in decades.

  • The increase in prices were driven by a supply and demand imbalance.

  • Inflation pressures should ease later this year and the markets might be overestimating the Fed.


Recently we have seen inflation readings that show consumer prices rising at the fastest annual pace since 1982. Inflation could threaten business profitability, discretionary consumer spending, and potentially derail this current economic recovery. Investors expect the Federal Reserve to raise rates to the 1.75% to 2.0% range (equivalent of seven 25 bps rate hikes) to combat inflation this year. We feel that may be too aggressive as the catalysts behind the jump in inflation (recovering demand and supply constraints) start to subside later this year.

The recent readings of inflation, such as the January Consumer Price Index, showed a 7.5% year-over-year jump. High inflation can reduce the purchasing power of consumers, especially if wage growth does not keep pace, which it has not done over the past year. Additionally, those relying on retirement income, such as pensioners, are negatively impacted. The potential result is that both could stifle consumer demand and derail this current economic recovery. Furthermore, if companies cannot pass costs onto consumers, inflation in the form of higher input costs (for example, wages, energy and raw materials) will likely hurt the current record profit margins, threatening business profitability and similarly affecting the economic recovery.

There are two primary reasons that led us into this inflation predicament. First, the combination of a strong economic recovery and a significant jump in consumer wealth from fiscal stimulus, surging home prices and strong stock market gains has led to an unprecedented demand for goods. On the other hand, a supply-chain crisis has been driven by COVID-19 disruptions and worker/equipment shortages. Thinking back to Economics 101, this combination resulted in a classic supply/demand mismatch, causing prices to rise.

Despite the headlines around the jump in inflation, we expect inflation to ease later in the year, though still remain above pre-pandemic levels. Annual inflation hovered around the Fed’s 2% target in the prior decade. On the demand front, as the economy transitions from an early cycle to mid-cycle recovery, which is usually signaled by the Fed’s first rate hike (more on that later), goods consumption should start to slow and help to reduce demand pressures on the economy. On the supply front, this reduced demand should allow companies to focus on rebuilding inventory, helping supply chains. Also, with worldwide COVID-19 cases declining and more people getting vaccinated, supply chains should further improve as workers return. We are already seeing signs of supply improvement. For instance, new auto sales, which had been hampered for nearly a year by a shortage of semiconductors, surged 20% last month. Also, just recently, the government reported a surge in U.S. imports and a massive jump in overall  company inventories in the fourth quarter GDP report. Both suggest overseas production has resumed and logistics are starting to deliver fresh supply to the U.S. economy. With officials at the Port of Los Angeles recently announcing that they expect cargo normalization by the end of 2022, supply constraints should be declining rapidly. 

The supply/demand imbalance has driven prices higher and inflation to levels not seen in decades. As part of their dual mandate, the Fed will attempt to combat higher inflation by raising interest rates, most likely beginning at their next scheduled meeting in March. Looking at the futures markets, investors are anticipating that the Fed will need to raise its primary interest rate tool, the Fed Funds Rate, to the 1.75% - 2.0% range by year-end. While we have noted many times throughout the past 12 months that the Fed needs to be more hawkish to combat inflation, we do feel that this current expectation may be too aggressive. Yes, the recent CPI reading was very high and we will likely get another strong reading for the month of February. However, after that, the combination of base effects, when year-over-year changes are smaller due to a high reading one year ago, and supply constraints should improve drastically.

We are in the belief that the Fed ends up being more conservative and does not raises rates to the same magnitude that the markets expect. Even with more favorable base effects and supply shortage improvement to help push inflation lower this year, so called “sticky” inflation, such as owners’ equivalent rent and food away from home, which rises faster than it declines suggests overall inflation will remain well above the Fed’s target for some time. With the labor market very tight, there is the possibility that the Fed overshoots and tightens too much. The probability of an economic soft landing is now unfortunately extremely low in our opinion.

We reiterate that in 2022, our primary investment themes are slowing economic growth, a more hawkish Fed, and an increase in market volatility. With market risks rising, we continue to anticipate more volatility in the near term. Any disruption to current expectations could be a headwind for stocks, and with stock market valuations priced to perfection, this could amplify any volatility. Still lingering stimulus, a financially healthy consumer and the eventual abatement of supply chain issues suggest limited market downside. We maintain that diversification is the key in this market.

In these times, we can help you stay focused on your long-term risk and return goals and help you with your personalized investment objectives.

This report is created by Cetera Investment Management LLC. 

About Cetera® Investment Management
Cetera Investment Management LLC is an SEC registered investment adviser owned by Cetera Financial Group®. Cetera Investment Management provides market perspectives, portfolio guidance, model management, and other investment advice to its affiliated broker-dealers, dually registered broker-dealers and registered investment advisers.

About Cetera Financial Group
“Cetera Financial Group” refers to the network of independent retail firms encompassing, among others, Cetera Advisors LLC, Cetera Advisor Networks LLC, Cetera Investment Services LLC (marketed as Cetera Financial Institutions or Cetera Investors), Cetera Financial Specialists LLC, and First Allied Securities, Inc. All firms are members FINRA / SIPC. Located at 655 W. Broadway, 11th Floor, San Diego, CA 92101. 

Disclosures
Individuals affiliated with Cetera firms are either Registered Representatives who offer only brokerage services and receive transaction-based compensation (commissions), Investment Adviser Representatives who offer only investment advisory services and receive fees based on assets, or both Registered Representatives and Investment Adviser Representatives, who can offer both types of services. The material contained in this document was authored by and is the property of Cetera Investment Management LLC. Cetera Investment Management provides investment management and advisory services to a number of programs sponsored by affiliated and non-affiliated registered investment advisers. Your registered representative or investment adviser representative is not registered with Cetera Investment Management and did not take part in the creation of this material. He or she may not be able to offer Cetera Investment Management portfolio management services. Nothing in this presentation should be construed as offering or disseminating specific investment, tax, or legal advice to any individual without the benefit of direct and specific consultation with an investment adviser representative authorized to offer Cetera Investment Management services. Information contained herein shall not constitute an offer or a solicitation of any services. Past performance is not a guarantee of future results. For more information about Cetera Investment Management, please reference the Cetera Investment Management LLC Form ADV disclosure brochure and the disclosure brochure for the registered investment adviser your adviser is registered with. Please consult with your adviser for his or her specific firm registrations and programs available. No independent analysis has been performed and the material should not be construed as investment advice. Investment decisions should not be based on this material since the information contained here is a singular update, and prudent investment decisions require the analysis of a much broader collection of facts and context. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The opinions expressed are as of the date published and may change without notice. Any forward-looking statements are based on assumptions, may not materialize, and are subject to revision. All economic and performance information is historical and not indicative of future results. The market indices discussed are not actively managed. Investors cannot directly invest in unmanaged indices. Please consult your financial advisor for more information. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability, and differences in accounting standards.

A diversified portfolio does not assure a profit or protect against loss in a declining market.