Douglas Castro

ADC Wealth Management, LLC

30D Broadaway, Suite 200

Massapequa, NY 11758

516.308.7514

douglas@adcwealthmgmt.com

Market Update
(all values as of 06.28.2024)

Stock Indices:

Dow Jones 39,118
S&P 500 5,460
Nasdaq 17,732

Bond Sector Yields:

2 Yr Treasury 4.71%
10 Yr Treasury 4.36%
10 Yr Municipal 2.86%
High Yield 7.58%

YTD Market Returns:

Dow Jones 3.79%
S&P 500 14.48%
Nasdaq 18.13%
MSCI-EAFE 3.51%
MSCI-Europe 3.72%
MSCI-Pacific 3.05%
MSCI-Emg Mkt 6.11%
 
US Agg Bond -0.71%
US Corp Bond -0.49%
US Gov’t Bond -0.68%

Commodity Prices:

Gold 2,336
Silver 29.43
Oil (WTI) 81.46

Currencies:

Dollar / Euro 1.06
Dollar / Pound 1.26
Yen / Dollar 160.56
Canadian /Dollar 0.73

A Higher Rate of Inflation

The talk of inflation and interest rates has been in the papers for years now, with people on the edge of their seats wondering what the Fed’s next move will be in order to combat the inflation. This talk is nothing the news has not seen before, great bouts of differences in the inflation rate
have occurred over time and each time the economy cycles back to a tolerable place. In this memo we will go over what recent events have caused the inflation we’re seeing today, how the neutral rate of inflation may be raised, and where we could possibly see inflation going.

Causes of Inflation

As defined by the United States Department of Labor, inflation is the overall general upward price movement of goods and services in an economy. Inflation is associated with too much demand and not enough supply, or a rapid growth of the money supply (CITE HBR). With COVID, the people of the United States have experienced intense changes with the different lifestyle the country sustained for not only the months of lockdown, but also the following two years. Because of the lifestyle change, the economy changed alongside it. We went from record low interest rates during the pandemic record to very high interest rates in an attempt to curb inflation. Numerous factors contribute to the increased rate of inflation besides the mentioned causes, however they are not as direct. What some may say, others may disagree with, because the intricacies of how the economy functions (i.e. why it functions the way it does) cannot be pinpointed to one sole cause. Monetary policy, government spending, a change in what society needs, and a great amount of other events can cause an increase in inflation. It should be no
surprise that with the economy going through unforeseen events in 2020 and changing monetary policy that we are in a volatile economy.

Shown above: Federal Funds Effective Rate. The Federal Funds Effective Rate is the interest rate that depository institutions trade federal funds with each other overnight. Typically, a lower cost of borrowing can lead to overborrowing and inflation.

 

 

 

Raised Neutral Inflation Rate

The neutral rate of inflation has been determined by policymakers at 2% and formalized in 2012 (CITE Furman). This number is simply a target for where inflation should try to be kept, with the likely possibility of the number varying above or below the target rate. In the past year we have seen the Fed trying to lower this figure by increasing the interest rates, and while the difference has closed, they are still attempting to return inflation back to the 2% target rate. Here comes the question of tolerance. How much more can Americans tolerate the interest rates being at the rates they are at now? Is the Fed pushing too much to try to reach the 2% mark at the expense of jobs and the risk of recession, which is really just a made up target rate decades ago? What if we let go of that 2% target rate idea and instead opted for allowing the inflation rate to settle slightly above it? If this does become the case, it is important for the Fed to be confident in their
decision, “shifting to a higher inflation target in a manner that wasn’t credible could disrupt these expectations, leading to soaring inflation premiums for borrowers, driving up government’s deficits, and reducing private investment” (CITE Furman). This is not to say that the Fed should just forgo the 2% rate, moreso that reality has changed since this target was set and that a shift to a slightly higher target rate is not something that is out of the question. It is in everyone’s best interest for inflation to stay at bay with hope that the Fed makes the right decision for that to happen in these next coming months.

 

Disinflation Prior and the Possibility of Inflation Lowering

We know that inflation needs to be lowered, so other important areas to look at are disinflation and also deflation. Disinflation is when inflation is still rising, just at a slower rate than prior. It is imperative to avoid deflation because although the sound of prices decreasing may sound nice, it actually means that the economy is weakening. One example of deflation that occurred was in the 1920s, “a collapse in aggregate demand and credit channels, along with policy mistakes,
drove deflation of the late 1920s and early 1930s” (Kumar et al., 17). There is such a thing known as opportunistic disinflation, and in the late 1900s there was a period where inflation was lowered from 11% to 3.5%, “the central bank would sustain boom periods with low rates but quickly rise rates after recessions to preserve a lower rate of inflation” (Haltom). The long term effect of this was reducing the great effect that such a high rate of inflation would have on the economy. Recent events have also likely increase the neutral rate of inflation which consist of, but are not limited to, swelling government deficits, investment in clean energy, and productivity boosting investment opportunities such as AI (Timiraos). There is a happy medium where the economy can stabilize at in a perfect world, however, because of the different aspects that fuel what inflation sits at, it can be said that inflation may just have to remain at a slightly higher rate than what we were used to.

https://www.dol.gov/general/topic/statistics/inflation (inflation definition)

Notes: raised neutral inflation rate, what led to deflation prior (China/outsourcing/tech/mobility), can any of that be reproduced to lower inflation? What can lead to inflation (green energy push, higher min wage push higher government spending, higher global debt levels)

https://www.wsj.com/economy/central-banking/why-the-era-of-historically-low-interest-rates-could-be-over-49bcdc59

– Neutral rate of interest: rate at which demand and supply of savings is in equilibrium → stable economic growth and inflation
– “Swelling government deficits and investment in clean energy could increase demand for
savings” → makes neutral rate higher, higher public debt
– Productivity boosting investment opportunities (AI) could increase neutral rate
– Business investment depreciates faster

 

 

https://www.cfr.org/blog/history-and-future-federal-reserves-2-percent-target-rate-inflation-0

– 2% target rate was adopted in 2012 following New Zealands trend (maybe?)
– Why is it 2%?
– Hard to measure inflation directly (upward bias in inflation measures)
– Leaves room to cut interest rates to stimulate economy
– Buffer against deflation
– Question: is it worth raising interest rates even further risking recession and jobs, just to bring inflation down to a percent that is random?
– Flexible average 2% in the long run target rate

https://www.wsj.com/articles/the-fed-should-carefully-aim-for-a-higher-inflation-target-reserve-powell-greenspan-5fef5051 (Furman)

– Higher inflation can help the fed stimulate investment (any given nominal borrowing cost becomes less onerous when businesses can count on future price               increases to meet it)
– 1990s policy makers decided on 2% and formalized in 2012
– Transitioning to a slightly higher inflation rate- Intent is not to raise inflation just to avoid pain of getting inflation down
– Need to stick with target inflation rate so fed’s credibility is not questioned

https://www.imf.org/external/pubs/ft/def/2003/eng/043003.pdf (history of deflation)

– Collapse in aggregate demand and credit channels & policy mistakes drove deflation in the late 1920s and early 1930s

https://www.richmondfed.org/publications/research/econ_focus/2014/q3/jargon_alert (Haltom) (Disinflation)

– Most favorable disinflation period: 1980s went from 11% to 3.5%
– “Opportunistic disinflation”: central bank would sustain boom periods with low rates but quickly rise rates after recessions to preserve lower rate of inflation →         gradual disinflation
– Short term cost of unemployment
– Long term gain in reducing distortions of inflation
– Deflation is not good → be vigilant in disinflation episodes
– 2008 great recession
– Interest rates were near zero to stimulate growth and mitigate risk of deflation

 

https://hbr.org/2022/12/what-causes-inflation

– Inflation is driven by too much demand relative to supply
– Supply shocks: major disruptions to an important economic input
– Growth of money supply rises too quickly

https://fred.stlouisfed.org/series/FEDFUNDS#

– Federal funds rate: interest rate that depository institutions trade federal funds with each
other overnight.
– Lower rate → lower cost of borrowing typically, can lead to overborrowing and inflation

 

 

 

 

 

 

 

Works Cited
Board of Governors of the Federal Reserve System (US), Federal Funds Effective Rate [FEDFUNDS], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/FEDFUNDS, October 1, 2023.
Furman, Jason. “The Fed Should Carefully Aim for a Higher Inflation Target.” The Wall Street Journal, 20 Aug. 2023,
www.wsj.com/articles/the-fed-should-carefully-aim-for-a-higher-inflation-target-reservepowell-greenspan-5fef5051. Accessed 2 Oct. 2023.
Haltom, Renee. “Disinflation.” Federal Reserve Bank of Richmond, Sept. 2014, www.richmondfed.org/publications/research/econ_focus/2014/q3/jargon_alert. Accessed 2 Oct. 2023.
“Inflation and Consumer Spending.” US Department of Labor, Inflation and Consumer Spending| U.S. Department of Labor. Accessed 2 Oct. 2023.
Kumar, Manmohan S., et al. “Deflation: Determinants, Risks, and Policy Options— Findings of an Interdepartmental Task Force.” International Monetary Fund, 30 Apr. 2003, www.imf.org/external/pubs/ft/def/2003/eng/043003.pdf.
Timiraos, Nick. “Why the Era of Historically Low Interest Rates Could Be Over.” The Wall Street Journal, 20 Aug. 2023, www.wsj.com/economy/central-banking/why-the-era-of-historically-low-interest-rates-could-be-over-49bcdc59. Accessed 2 Oct. 2023.