Learn why you may be able to retire earlier than you think.
This field is for validation purposes and should be left unchanged.

The Monetary Policy Pendulum Has Swung

For most Americans, their New Year’s resolution comes in the form of eating better, exercising more, or spending more time with their family. My resolution is to do everything I can to keep my family happy and sane while we wait to move into our new home. With 6- and 3-year-old boys and a newborn daughter, I feel like this is all I can handle for 2022! However, for Jerome Powell, Chairman of the Federal Reserve, it appears his New Year’s resolution is to combat inflation head-on.

For an institution as large as the US Federal Reserve, one that manages a multi-trillion-dollar balance sheet and sets interest rate policy impacting many trillions more, they have certainly acted far more nimbly and quickly than one would have ever thought just a few years ago. It wasn’t just a few months ago the Fed was discussing how inflation was “transitory” and would abate as the supply chain loosened up throughout the remainder of 2021 and into 2022. That forecast is clearly no longer true, and the Fed has said just as much throughout their previous meetings.

More recently, Powell and the Fed’s board of governors have gone out of their way to suggest inflation is their single largest point of focus for 2022. Price stability is one-half of the Fed’s mandate, with maximum employment as the other half. Currently, inflation has increased by 7% over the last year as measured by the Consumer Price Index. This is the highest reading since June 1982.1 And in a scenario where inflation doesn’t appear to be receding on its own due to a pandemic continuously impacting the supply chain, the Fed understands that in order to meet their price stability mandate, they must act.

This action has come in the form of a relatively swift pivot from exhibiting a path for accommodative policy, albeit one that would gradually recede over time, to an explicit intention to withdrawal accommodation due to persistent inflationary pressures. Jerome Powell commented in his Senate confirmation hearing recently that maintaining stable prices will be critical to sustaining the growth in the economic recovery. This suggests the Fed’s focus will be squarely fixated on keeping inflation in check throughout 2022. At this point, here’s how most forecasters are expecting this to happen:

  • Winding down of bond purchases by March 2022. Recall the Fed was purchasing $120 billion of government bonds each month until they began tapering that number in the second half of 2021 and accelerating that tapering in December. This policy has been known for a few months now.
  • Increasing the federal funds rate off of zero percent. Current expectations are for the Fed to begin hiking rates at the March FOMC meeting. The current consensus is for four 0.25% rate hikes in 2022, though a fifth hike in 2022 is quickly becoming a possibility. This could come in the form of the first hike in March being 0.5% and increasing by 0.25% after that.
  • Reduction of the Fed’s $8 trillion-plus balance sheet. This is the newest form of monetary tightening recently brought up by Powell and other Fed governors. By actively selling off bonds from the Fed’s balance sheet, they are withdrawing liquidity from the system. This measure most directly impacts the demand side of the inflation equation as fewer dollars floating around in the economy would mean fewer dollars to spend on goods and services

The last point about reducing the Fed’s balance sheet really encapsulates one of the key issues we’re seeing with inflation and why the Fed is unlikely to solve this problem unilaterally. The Fed has far more power to impact the demand side of inflation than they can with the supply side. To put this into basic terms, when the Fed is accommodative, they’re putting money into the system to be used by financial institutions to lend out to corporations, so those corporations can spend that money on projects, employ more workers, or increase their reserves to stabilize their balances sheets. That money has very little capacity to impact supply-side inflationary factors such as port congestion, energy prices, and logistical bottlenecks on a global scale.

The good news is we’re seeing signs congestion could be near its peak on the supply side at the same time the Fed is pivoting towards directly combating inflation from the demand side. This comes in the form of energy prices falling from their peaks (though these prices are volatile and have been increasing again recently) and automakers increasing manufacturing capacity, which should help reduce new and used car prices towards the second half of 2022.

The Omicron variant of Covid, just like the Delta variant, has pushed back expectations for when these supply-side pressures could normalize. Though, keep in mind that if the path of positive Covid cases in America follows the trend of South Africa, we should begin to see Omicron impacting the supply chain less than what it has in recent months. We would also expect any additional variant waves to further hamper the supply side of the equation and delay a normal return.

Separately, wage inflation will be under the microscope as the Fed can only do so much to prevent company’s paying their staff more due to a lack of skilled workers and an increased demand for those workers. If wage inflation looks like it’s running hot the Fed may seek to act quicker on their rate hike schedule or reducing the size of their balance sheet.

Our original assumption of inflation being temporary was based on a normalization of the global supply chain, though as we’ve seen, there is no shortage of complicating factors inhibiting a return to “normal.” With that said, we can see how the momentum is shifting from global authorities believing inflation will correct itself without intervention to governing bodies understanding action must be taken to combat inflation. This gives us a sense of optimism that while inflation may remain elevated for longer than we expect, runaway inflation should remain a relatively low risk to the continuing economic recovery.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

  1. https://www.cnbc.com/2022/01/12/cpi-december-2021-.html 

Schedule A Financial Consultation

  • This field is for validation purposes and should be left unchanged.

Are We Right for You?

Schedule Your Complimentary Consultation Today!

About Us

Bernicke Wealth Management, Ltd. (Bernicke) is an independent, multi-disciplinary firm with 25 employees located outside Eau Claire, in Altoona, Wisconsin. Our financial advisers provide wealth management services for individual investors, businesses, foundations, and nonprofits, including investment planning, retirement planning, estate planning, and tax planning.

© 2022 Bernicke Wealth Management, Ltd.

Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Great Valley Advisor Group, a registered investment advisor. Great Valley Advisor Group and Bernicke Wealth Management are separate entities from LPL Financial. The LPL Financial registered representatives associated with this website may discuss and/or transact business only with residents of the states in which they are properly registered or licensed. No offers may be made or accepted from any resident of any other state.