Is the Fed sending us into a recession with their promise to raise interest rates? Maybe. But why are they so committed to raising rates, if it could send the economy and the stock market into a further downturn?
Well, we need to take a look at where we are at today. Since the Great Recession of 2008, the federal reserve has been pumping money into the economy through their Quantitative Easing programs by buying both government and corporate bonds, flooding the economy with easy money and LOTS OF CASH! The Fed's balance sheet prior to the 2008 crash was about $870 billion dollars. Today, it is close to $9 TRILLION!
That's a lot of new printed money in circulation. All that new money will eventually make our money worth less. This is called "debasement" of the currency. With so many years of easy money, we are now seeing the results of what cheap money will eventually do. It has created significant INFLATION.
Too many dollars chasing too few goods and services, makes the price of those goods and services rise. To add insult to injury, energy prices have shot up this year which makes shipping costs more expensive. The most recent CPI (consumer price index - a measure of the price of a basket of goods excluding food and energy) has risen 6.8% from a year prior. This is greater than analysts had predicted. It looks like that trend has been consistent all year.
Having said that, the Fed can only effect demand. By raising rates, it will undoubtedly slow down spending. People will be less likely to pull cash out of their home equity to remodel or make a large purchase. Businesses may be less likely to reinvest and take out loans when there could be a potential slowdown in spending and consumption. Unfortunately, the Fed cannot impact the supply side effect. Between the lock downs in China and the supply chain disruptions, a lack of supply coupled with strong demand will also impact price pressure to the upside, which is probably partially to blame.
It's been a long time since we have seen a recession and complacency has left investors feeling uncertain about what's going on. Historically, recessions are a normal part of the growing process. The business cycle suggests a recession is followed by a trough. Then, we will eventually see economic growth come back and hit a peak and then a contraction again. And so on. The normal lifespan of a full business cycle is about 5 years.
The definition of a recession is the drop in GDP (gross domestic production) two successive quarters in a row. So, it's quite likely we are already in a recession right now, since the economy shrunk by a modest 1.4% for the first quarter. In fact, the worst may not be over yet. At least until inflation begins to show some signs of moderation. Herein lies the risk of investing in the markets, at least in the short term. Finding yourself at an inopportune time, needing to pull money out when we are heading into a recession. That is why it is so important to have a customized financial plan that segments your investments, based on the timing of when you will need them. This too shall pass, and the economy will again re-emerge into a growth phase and if history repeats itself, should reward investors with a long-term time perspective and patience.
If you have questions about your investments or financial goals, give us a call. I can be reached at 386-299-2893 and will be more than happy to help you reach your financial goals.