In what can only be described as a major shift in US monetary policy, Federal Reserve Chairman Jerome Powell announced late last week that the Fed will no longer attempt to keep inflation consistently at 2%. Instead they will attempt to hold inflation rates to an average of 2% over time. According to Powell this new strategy hopes to create “a strong labor market” and to sustain low unemployment “without causing an unwelcome increase in inflation.”
In general terms, this shift in policy which now focuses on the average inflation rate instead of the current inflation rate gives the Fed license to keep rates low even if inflation rates rise above well above 2%. This means the historically low rates we are currently experiencing may be around for a while. In the short-term, this is undoubtedly welcome news to Wall Street and to those planning to invest in a new home soon. However, these actions by the Fed pose certain dangers as well.
After market crashes in both 2008 and 2020 many investors have grown weary of the stock market and have sought solace in safer low risk investment products. You can hardly turn on a radio on the weekend without hearing an advisor warning against market risk as they attempt to convince you their fixed income vehicles like bonds and annuities are the way to go. However, on top of the default risk that always exist with these types of investments, this new policy provides the double whammy of lower return rates and higher inflation risk. Being locked into something that is growing by 1% annually while the buying power of those funds is potentially dropping by significantly more than that is a serious risk that needs to be considered before buying one of these products.
Because it has been so long since inflation was a serious concern for our economy, the devastating impact of it can be underestimated. But talk to someone living in the US in the 1970’s and ask them what it was like to live through a decade where the average annual inflation rate was 7.25%. If such an inflation rate were to return it would be catastrophic for our nation especially for those living on a fixed income.
As you might have gathered from this column and others I have written, I am not a fan of how the Fed has consistently kicked the proverbial can down the road through their easy money policies. Rather than allowing market factors to produce a reasonable correction they have continued to artificially prop up our economy. In my opinion this new inflation strategy is simply a continuation of the same dangerous tactics they have been using for quite some time. While I hope I’m wrong, I fear what will happen when this house of cards the Fed continues to build taller eventually falls.