Inflation is the hot topic of 2022 as it is the main culprit behind the US stock market going into bearish territory. With inflation comes rising interest rates implemented by the Federal Reserves to try to curb inflation. The interest rate hikes resulted in companies incurring more debt when taking loans, which hurt their profit margin, which in turn affected their share prices.
Even if you are not an investor, you would have by now felt the full brunt of inflation as the price of everything increases significantly, from food to fuel to essential items.
In this article, I wish to share with you 3 reasons why I think inflation will eventually be under control.
Reason 1: The Fed Is Working On It
The Federal has often been criticized for repeatedly making the wrong judgment call to curb inflation. In 2021, Fed Chairman Jerome Powell famously said that inflation is transitory and shelved the plan of Quantitative Tightening (QT) and rate hikes. The Fed’s Quantitative Easing (QE) policy, which includes printing loads of free money, is what led to the sky high inflation figures we are seeing now.
However, let’s take a moment to appreciate what the Fed has done to save the economy when we were hit by the worst pandemic in recent history. Had it not for the Fed’s intervention, the whole stock market might be in a sorry state for as long as the pandemic lasted. If that happens, the whole world will be dealing with high unemployment rate and many other more serious consequences when many companies go bankrupt due to the pandemic.
So, the Fed may be slow and was previously still hoping to achieve a win-win situation of saving the economy as well as keeping inflation under control, but they are playing catching up now with the interest rate hikes and QT. Essentially, thr Fed is trying to curb the high demand that is causing prices to inflate.
In a rising interest rate environment, the demand will definitely go down because people will have to take on more debt if they wish to borrow money. Imagine buying a 1M property and taking a loan of 800k. In a zero interest environment, you just have to focus on paying down the loan. But if interest rises to 3%, then you will be paying an extra 24k more per year or 240k more in 10 years. If the interest rate rises higher than 3%, then the loan amount you pay every month increases. This is something similar to the cooling measures of increasing property purchase taxes that the Singapore government implemented to discourage property owners from property speculation and causing property prices to skyrocket.
In my humble opinion, the Fed should keep up with higher interest rate hikes over the next few months to bring inflation down once and for all. The stock market may suffer further decline but short-term pain is definitely better than long-term pain. The Fed already has the bullet from the 9.1% increase in June CPI data to justify continuing with 75 basis points or higher rate hike.
Reason 2: Recession Fears
The aggressive interest rate hikes will lead to the whole economy slowing down and a recession to occur (2 consecutive quarters of GDP decline). When a recession occurs, companies will start retrenchment exercises to cut down on overheads and operating costs. In a recessionary environment where people worry about job security and livelihood, it is also likely that consumer spending will drop, especially on non-essential items. People will naturally want to save up more and spend on the necessary, just in case they need the spare cash to tide through any emergency. All of these will lead to a demand drop which will then lead to inflation dropping.
Reason 3: Inflation
The 3rd reason why inflation will be under control is ironically due to inflation itself. When prices of everything start to get higher, consumers will either switch to an alternate product or stop buying the items altogether, especially if it is a non-essential item. For example, you may be a huge fan of Hawker Chan’s roast pork rice and because of the huge price hike, you may switch to eating roast pork rice at another eatery which is tasty but cheaper. Alternatively, you may also pack your lunch to work and save up more money on your meals. All these cost-cutting measures also reduce the demands on existing goods and services, which will bring the prices down.
Reason 4: Falling Oil Price
The fourth reason why I believe inflation will be under control is because of the falling oil prices. The current oil price (as of 15 July) is $96 per barrel.
When the Ukraine War broke out and sanctions were made against Russian oil imports, the whole world suffered the consequence as the significant reduction in oil supply caused oil prices to shoot up as high as $125 per barrel. That led to higher inflation as many products that we use today are made from oil or oil derivatives. When oil price drops, it means the raw material costs for the products that we use also drop and this will lead to a decline in inflation.
US president Joe Biden is also visiting Saudi Arabia and is expected to discuss the ramping up of oil supply to meet the world’s needs.
With the above reasons in mind, I am optimistic that inflation will come down by end of this year or early next year. However, for that to happen, the Fed must not loosen the interest rate policy too quickly. The Fed must continue to tighten and increase interest rates until inflation figures are falling for consecutive months. Also, the market must continue to absorb the short-term pain during this period, which may also prompt investors to save more and spend less, so that they have enough funds to buy the dip in fundamentally good companies.
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