Why Are We Still Talking About Inflation?

Understanding Inflation, Federal Reserve Policy, and the Markets

Why Inflation Continues to Matter

Over the last 4 years we have all become more intimately acquainted with inflation in our daily lives – groceries, insurance, utilities – and how both every day and one-off expenses seem to rise without end. Not only does has inflation continued to erode our purchasing power, but it remains a defining factor in market performance. For instance, when the Consumer Price Index (CPI) data for March was higher-than-expected, markets reacted negatively. This article explores that connection and how effective financial planning, and portfolio management can protect us from factors that would otherwise be beyond our control.

Source: BLS, FactSet, J.P. Morgan Asset Management.
CPI used is CPI-U and values shown are % change vs. one year ago. Core CPI is defined as CPI excluding food and energy prices. The Personal Consumption Expenditure (PCE) deflator employs an evolving chain-weighted basket of consumer expenditures instead of the fixed-weight basket used in CPI calculations.
Guide to the Markets – U.S. Data are as of March 31, 2024.

Why We Keep Talking about the Fed

The Federal Reserve, or the Fed, plays a crucial role in managing the U.S. economy’s rate of inflation. It sets the country’s monetary policy by manipulating interest rates and influencing money supply. The Fed’s primary goal is to achieve maximum employment and stable prices. To control inflation, the Fed might increase interest rates, making borrowing more expensive. This usually slows down spending and investment, which can help reduce inflation. Conversely, to stimulate the economy, the Fed might lower interest rates, encouraging borrowing and spending.

Source: Board of Governors of the Federal Reserve System (US)
Release: H.15 Selected Interest Rates
Units:  Percent, Not Seasonally Adjusted
Frequency:  Monthly
Averages of daily figures.

Influence on Market Performance

Market performance is deeply influenced by the Fed’s policy decisions. For instance, higher interest rates often lead to higher yields on bonds, which can make them more attractive compared to stocks. This can cause stock prices to fall, particularly for growth-oriented companies that rely heavily on borrowing. Conversely, when rates are low, stocks often perform better because companies can borrow cheaply to invest in growth, and bonds yield less, making stocks more attractive.

Expectations versus Reality

Investors devote a great deal of time and energy trying to understand the direction of the Fed. Comments from the Chair or other members of the Federal reserve are carefully dissected alongside all manner of economic indicators – these assessments are reflected in pricing for securities and changes in expectations can move markets. The recent higher than expected CPI numbers as an example, shifted expectations of rate drops back from June of 2024 to September or later and the impact rippled across markets.

Putting it all together

As individual investors, we have no control over inflation, Federal Reserve policies, or market performance. Even the most accurate market forecasters can be wrong, as unforeseen events—like pandemics or wars—can disrupt even the most well-thought-out plans. The key is to align your financial strategy with your cash flow, liquidity needs, and risk tolerance, preparing for the worst while hoping for the best.

What’s Next

If you are unsure about how inflation and risk are managed within your financial plan and portfolio—or how these elements interconnect—it is time to gain clarity. Send us a note and we’ll show you how they are – or how they could be.

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