Inflation, Quantitative Easing (QE), and Growth

October 11, 2021
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Quantitative Easing (QE) is the Fed buying bonds to keep interest rates down and provide the economy with liquidity to continue doing business given impacts of Covid – 19 to businesses.

Vaccines offer hope to the market for controlling the Covid – 19 viruses even against low vaccination.

However, the market history clearly shows that the primary bear market risk for investors is recession which could be due to declining earnings, lower dividends, and an increase in bankruptcies.

Key positive factors for continued monitoring of interest rates, and inflation:

  • The September Federal Open Market Committee (FOMC) overnight lending rate to member banks and maintaining its historically low range of 0% to 0.25%. The feds QE program 2020 purchased $800 billion monthly in treasuries and $40 billion monthly in mortgage-backed securities buying program is to provide enough liquidity given the pandemic-related economic stress.
  • As the Federal Reserve reduces the QE program it should be in a better position to determine the direction of the federal funds rate and the monetary accommodation prevailing since the spring of 2020.

  • Fed Chairman Powell has made it clear that the process of raising short-term rates will not begin until after the QE tapering process is complete – in about 8 months. Before the FOMC considers raising the Fed funds rate which will depend on the ongoing health of the economy.

  • Inflation has certainly spiked. It is our view, based on Fed activity and the federal treasury’s emphasis, inflation should subside in the spring an average 2% – 3% going forward. The supply chain effects may linger for a while as the issue of shortages could take time to resolve. When the dust settles, expect manual price gain to the 2/3% level.

  • The overall index (CPI) currently shows a one year of 5.3% with a core CPI of a one-year gain of 4%. The Cleveland Federal Reserve Bank median CPI provides a key input on inflation. This index represents the one-month inflation rate of the CPI component. These figures are both higher when compared with the gain and less volatile core Personal Consumption Expenditures (PCE) for one year at 4.2% as this excludes food and energy. The government adjusts Social Security benefits on the higher while the Federal Reserve and most economists view the PCE index, a less volatile measure, as a better barometer of personal inflation. Given supply chain and labor force short ages, it's reasonable to expect an annual increase in the CPI area of 6% for now as the graph illustrate.

GDP growth energy to fundamental core elements:

Two core elements to review are (1) labor force growth and (2) productivity growth. Nothing has changed with these two core elements to affect growth. The pandemic has produced an increase in productivity as companies invest in laborsaving technology to deal with the lack of qualified workers. Therefore, additional productivity growth may be expected to settle close to the 2% level. Current GDP estimates are for 5 to 6% and a more modest 3% to 4% in 2022 is the process of reopening the economy moves forward in the quarters ahead.

Overall, based on interest rates and the expectation that the level of inflation will return gradually to a 2% to 3% range, expect modest market gains the rest of 2021 and an upside estimate potential for 2022 with sufficient progress being made against the pandemic. Encouraging evidence that the Delta variant wave is showing signs of slowing.

The month of September lived up to its historical tendency to present challenges for equity investors. Although the S&P 500 index declined 4.76% in September, the index shows a solid gain for the year. Several concerns, included in future Fed tightening fears are the debt ceiling, the volatile October market history, and Washington DC turmoil. The absence of pre-recession evidence remains the key positive issue as earnings are expected to increase through 2022. Again, we still feel dollar cost averaging is a good strategy to follow and we remain fully invested.