28 Oct 2022
What is the way out?
Many investors are wondering how it is possible that inflation is running close to 8%, but the 5 year forward breakeven rate implied by the TIPS markets suggests that inflation will be approximately 2%? The Fed too, has talked about how future inflation will approach 2%. That seems like a long shot right now. But is it?
The below chart of inflation through the 1970s shows how this is possible. Inflation typically causes the Fed to raise interest rates, which can slow the economy or even induce a recession, and temper demand. On the other side of the inflation equation, supply shocks tend to get worked out in time. Both factors can result in inflation declining, and sometimes rapidly.
Inflation through the 1970s
Nuances to consider
- During the 1970s, inflation increased close to 10% from low to high. Today, inflation has risen almost 8% from low to high.
- Inflations regimes historically haven’t lasted much longer than 3 years. Today, we are currently 2 years and 5 months into this inflation regime.
- After some sputtering, the Fed has been highly reactionary to this inflation regime, raising the Fed Funds rate at a near record pace.
- Just like in the 1970s, a major component of this inflation regime is supply shock. Is the war in Ukraine or are supply chain issues permanent factors now?
- Every general not only fights the last war, but they also expect the worst war. In capital markets, the worst case rarely materializes.
The views expressed represent the opinion of Frontier Asset Management. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Stated information is derived from proprietary and nonproprietary sources that have not been independently verified for accuracy or completeness. While Frontier Asset Management believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. The use of such sources does not constitute an endorsement. Frontier does not have an affiliation with any author, company or security noted within. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and the Frontier Asset Management’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements. Investing in securities involves risks, including the potential loss of principal. Past performance is not indicative of future results.
Inflation is the decline of purchasing power of a given currency over time. A quantitative estimate of the rate at which the decline in purchasing power occurs can be reflected in the increase of an average price level of a basket of selected goods and services in an economy over some period of time. The rise in the general level of prices, often expressed as a percentage, means that a unit of currency effectively buys less than it did in prior periods.
Frontier Asset Management is a Registered Investment Adviser. The firm’s ADV Brochure and Form CRS are available at no charge by request at info@frontierasset.com or 307.673.5675 and are available on our website www.frontierasset.com. They include important disclosures and should be read carefully.
102522DWM102523