What's in Store for Inflation in 2022

What's in Store for Inflation in 2022

January 12, 2022

By now, we have all noticed the sharp increases in consumer prices from big-ticket items like houses and cars to our everyday expenses like gas and food. You don't have to read the headlines to know that inflation has been ramping up during 2021, as supply chain disruptions and labor shortages proved to be more tenacious than initially projected. Levels of inflation this high haven't been seen since today's retirees were starting out in their careers. Is this a long-term trend, or will it resolve in the near-term back to something like the Federal Reserve's stated goal of an average of 2 percent? Plus, everyone wants thoughts on the top question our clients ask: what can investors expect?

The Recent Readings 

The most recent read on inflation is the December number that the Bureau of Labor Statistics released on January 12th. The rate of 7.0% over the last 12 months is the highest in nearly 40 years, marking the seventh consecutive month of price increases. For those who can remember, numbers like those spark fears of a return to double-digit inflation.

What the Federal Reserve is Doing 

After insisting for almost the entire year that high inflation would be "transitory," Federal Reserve Chairman announced in advance of the Fed's December meeting that the language should be retired. At the December meeting, the Fed made clear that it is taking measures to curb inflation.

The first step is tapering the monthly asset purchases the Fed has been making since early in 2020. This removal of quantitative easing marks the Fed's allowing long-term interest rates to increase. Since prices move inversely to rates, the Fed's monthly purchases of $120 billion of U.S. Treasury and agency mortgage-backed securities had the impact of lowering long-term rates. Tapering started in November with a gradual decrease of $15 billion in purchases monthly, which would have resulted in tapering concluding in July 2022. The Fed's announcement doubled the reduction to $30 billion in December, and at this rate, tapering should finish in March.

 After tapering, the next step is for the fed to raise short-term interest rates. Here again, the Fed is signaling a more aggressive stance than at this time last year. The indications for one increase in 2022 have been replaced by the possibility of three increases in 2022 and further increases in 2023 and 2024. Given this schedule, interest rates may rise to just over 2% by the end of 2024. 

What's the Outlook for 2022?  

The Fed's projections for inflation in 2022 and 2023, also released at the policy meeting in December, are that the impact of rate increases, along with supply chain disruptions resolving, will be that inflation will likely fall to 2.6% by the end of 2022 and 2.3% by the end of 2023. Dropping from 7.0% to 2.6% inflation seems like a significant drop over a year, but we think inflation will moderate in 2022. 

The Fed has clearly started to take action to stem the flow of ridiculously easy money. At the same time, hopefully, we are past the point of free government-sponsored "helicopter" money falling to basically everyone living in the U.S. Mixing less easy fiscal and monetary policy and moving forward with a resolution to some of the supply chain issues will provide a recipe for lower inflation.   

What Can Investors Expect?  

Let's start with some good news. For now, higher inflation has had some positive benefits. The contribution amount to a 401(k) plan is pegged to inflation, and it increased to $20,500 for 2022. Similarly, social security benefits also saw a 5.9% increase. These increases will be permanent, allowing investors to save on taxes, increase income and have the potential to invest more in a stock market that has remained buoyant.  

Unfortunately, inflation has several downsides beyond higher prices. Interest rates will rise across consumer and mortgage debt. If you're using your credit lines or credit cards, you'll likely be paying more interest charges in the future. Some forethought in paying these balances down while rates are still low could save money long-term.  

In terms of investing, our standard principles remain good advice. Keep an eye out on your long-term plan. With the nice increase in asset prices, it's a great time to rebalance. Trim exposures that have grown outside your preferred risk parameters and look for companies with pricing power that can help hedge against inflation.

The Bottom Line 

We've struggled through a year of rising prices during 2021, and with a more hawkish Federal Reserve, we are on the verge of rising interest rates as well. In 2022, the Federal Reserve is tasked with balancing a reduction to inflation without choking the economy's growth as the recovery matures. Inflation readings, and subsequent Fed actions, will most likely be a major storyline of 2022. You can't control the Fed or the economy, but you can control how you prepare and react. If you need help, give us a call.

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