Fed To Taper, Inflation Rising, Retail Shortages Coming

Overview – On The Fed, Inflation & Retail Shortages

We touch on several bases today as we often do. We begin with the Fed which decided to start reducing its monthly purchases of Treasury bonds and mortgage-backed securities in November. This was not a surprise. Several members of the Fed’s policy committee also suggested the Fed is likely to begin raising short-term interest in 2022, a year earlier than previously indicated.

Following that discussion, we will look at the latest inflation report for September which came out last week. The Labor Department reported that the Consumer Price Index rose to an annual rate of 5.4% in September, the fastest pace in 13 years. After hoping for higher inflation over the last several years, the Fed now worries it may be too high. Be careful what you wish for.

Finally, we are hearing increasing warnings about shortages in consumer goods starting any day now. This is primarily due to growing glitches in the so-called “supply chain.” Hundreds of cargo ships are waiting off the coast of California to unload, and a similar backlog is building off the east coast as this is written. We are advised to do our Christmas shopping early this year.

There’s a lot to talk about today, so let’s get started.

Fed Monetary Policy To Dominate News Just Ahead

There are plenty of troublesome issues on the world stage today. The US is teetering on the verge of a debt default. China looks determined to take over Taiwan. World hunger and poverty are rising. Europe has become a hostage to Russian energy. Inflation in the US is at a 13-year high. The list goes on and on.

While problems on the world stage will continue to play out over the next year, I expect the Federal Reserve’s upcoming policy moves will draw increasing attention in the media and perhaps the markets. The Fed is expected to make two important policy shifts over the next year: dial back or eliminate monthly asset purchases and raise short-term interest rates.

The Fed has held short-term interest rates near zero for most of the last decade, mostly in response to the financial crisis of 2008-09. In addition, the Fed has been buying unprecedented amounts of government bonds and mortgage-backed securities, currently $120 billion per month, in an effort to pump liquidity into the financial markets.

As a result, the Fed’s balance sheet has exploded from about $3.5 trillion in 2019 to in excess of $8 trillion today. Nothing of this magnitude has ever happened before in history. So, the bottom-line question is: How does the Fed unwind this enormous position?

Fed balance sheet graph

The latest Fed Open Market Committee (FOMC) meeting was held on September 21-22 and the minutes from that meeting were released last week. As expected, the Fed decided to reduce asset purchases starting in November. The so-called “taper” will begin gradually with purchases trimmed by $10-$15 billion per month initially. It did not come as a shock to the markets.

The minutes from the September policy meeting did indicate most members of the FOMC are quite concerned about the rising level of inflation which has accelerated over the last year, coming in at an annual rate of 5.4% in September. While no specific action was agreed upon, the FOMC members did discuss the need to raise short-term interest rates in 2022 in order to head-off inflation, a full year ahead of previous guidance.

The members discussed two possible rate hikes in 2022. This is a big departure from the position the Fed has held for the last several years. It was not a big surprise, however. The markets have been expecting such a change in policy, as I have discussed in recent weeks. Stocks have been in a what so far has been a minor downward correction since early September.

Inflation Rises to 5.4% Annual Rate in September

Consumer prices have risen this year at the fastest pace in three decades, matching the brief oil-driven spike in 2008. The Consumer Price Index climbed 0.4% last month, the government reported last week – slightly above the pre-report consensus.

The pace of inflation over the past year, meanwhile, edged up to 5.4% in September from 5.3% in the prior month. That’s more than double the Federal Reserve’s 2% target. Higher prices for food, gasoline and rent drove most of the advance.

Consumer Price Index graph shows rise

Another closely watched measure of inflation that omits volatile food and energy costs rose 0.2% last month. This so-called “core rate” is closely followed by economists as a more accurate measure of underlying inflation. The 12-month increase in the core rate was unchanged at 4% in September, after reaching a 30-year high of 4.3% in June.

Broad shortages of labor and supplies are raising costs for companies and they are charging customers higher prices to maintain their profits. These shortages in some cases have gotten worse and there’s little end in sight.

Ongoing bottlenecks have forced the Fed to reconsider its view that inflation was only “transitory” and would fade by the end of the year. Chairman Jerome Powell recently conceded inflation would stay higher for longer than the Fed had initially expected.

Big picture: The big surge in inflation this year is likely to last well into 2022 – an outcome the Federal Reserve has only recently acknowledged.

Gasoline Prices At 7-Year High, Crude Oil Above $80/Barrel

Sign with gas prices near 6 dollars in CaliforniaThe average price for a gallon of regular unleaded gas in Texas last week was $2.87 according to AAA, but in some states the price soared above $6.00 a gallon last week. California is one such example. West Texas Intermediate Crude Oil prices soared to above $80 per barrel last week.

The climbing prices are a boon for the energy industry, which was battered during the pandemic, but bad news for the economic recovery as winter approaches.
Demand for energy is poised to get a boost from increased travel, as some destinations in Asia ease restrictions and the United States prepares to welcome vaccinated foreign visitors starting in November.

The bottom line: Most energy analysts believe oil and gas prices could stay a these levels for some time. Some including researchers at Citigroup and Bank of America believe the rally isn’t over yet, especially if we have a really cold winter. If that’s the case, they see crude oil going to $90 to $100 per barrel. Let’s hope not!

Widespread Shortages By The Holidays… Or Sooner

It’s mid-October, just the start of what the retail world simply calls “peak” season. But the industry is already in various forms of panic that usually don’t take hold until the weeks before Christmas.

Early in the year, the hope was the bottlenecks which gummed up the global supply chain in 2020 would be mostly cleared by now. Yet they’ve actually only gotten worse — much worse in some cases — and evidence is mounting that the holiday season is at risk.

Covid outbreaks have idled port terminals. There still aren’t enough cargo containers, causing some prices to spike 10-fold from a year ago. Hundreds of cargo ships, as far as the eye can see, are anchored outside ports in California waiting to unload. And it’s not just California. Schools of cargo ships are waiting outside ports on both coasts, Florida and even Alaska.

cargo ships waiting to dock

In addition, labor shortages have stalled trucking and pushed US job openings to all-time highs. And that was before UPS, Walmart and others embarked on hiring hundreds of thousands of seasonal workers to take on the peak retail season.

For all these reasons, retailers are advising consumers to start their holiday shopping now as there are likely to be a lot of shortages by the time we get to the holidays. Even worse, the supply chain bottlenecks will almost certainly result in even higher prices.

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Very best regards,

Gary D. Halbert

© Halbert Wealth Management

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