The U.S. Federal Reserve took on the fight against high inflation by raising interest rates 11 times in the last two years from .08% to 5.25-5.5%, which is a 23-year high. Overall, the Fed has been successful with inflation going from 8% in 2022 to 3.36% as of April 30, 2024. The long-term average for inflation is 3.28% and the Federal Reserve’s inflation goal is to lower inflation to 2.0%. The battle against inflation has yet to be won.
The initial high inflation came from supply chain disruptions and deglobalization during and after the pandemic shutdown. The current 12-month price increases are being led by Motor Vehicle Insurance with an increase of 22.2%. Shelter increased 5.7%; Personal Care increased 4.2%; and Sugar and Sweets increased 5.8%.
Going back to the last inflationary period in the 1970s and 1980s, Fed Chairman Paul Volcker had interest rates as high as 19-20%. This was great for savers. Bonds, CDs, savings and money markets had exceptional rates. On the flip side, loan rates were high.
Inflation hit a high for the period at 14.76% in April 1980, and by October 1981, the average 30-year mortgage hit its highest level at 18.63%. The average mortgage rate over the last 50 years is 7.74% and the current average rate is 7.863%.
At that time, the Federal Reserve was behind the eight-ball because inflation was extremely high, and the Fed was afraid to raise interest rates too high too quickly due to the threat of recession. The Fed acted too late, so it took more measures to drive inflation down to normal levels. The prime rate rose to 21.5% in 1981, which did lead to the 1980-1982 recession, during which unemployment rose to 10%.
Our Federal Reserve are historians as much as they are economists, and they learned their lesson from the high inflation and high interest rate Volcker decades. At first, the Fed’s opinion was that higher inflation was transitory and once the extremes of the pandemic were filtered out of the economy, all would be well. They realized their mistake and raised rates 11 times.
I don’t often say this, but this time is different. The Fed raised rates quickly, and while that typically would mean a recession, we have not seen one yet. Many are calling for a “soft landing.” In a typical scenario, tightening would lead to higher unemployment and lower spending. Not this time. The U.S. unemployment rate is at 3.8% and Pennsylvania’s unemployment is 3.4% as of March 2024. For context, a healthy unemployment rate is between 4%-6% with a long-term average of 5.70%.
Consumer spending is the largest component of the U.S. GDP. Spending per person is estimated to be down in 2024 but still healthy. However, the U.S. personal savings rate is down to 3.8% after spiking during the pandemic shutdown.
With inflation still sticky, the Federal Reserve may need to keep rates higher longer. They anticipated three Fed decreases in 2024, but with inflation staying high and economic indicators still solid, the Fed has room to wait. The good news is that this could lead to inflation getting to the 2% target. The bad news is the longer the Fed leaves rates high, the greater the chance of a recession.
All investing is subject to risk, including possible loss of the money you invest. Nothing in this article should be construed as investment or retirement advice. Always consult with a professional advisor and consider your risk tolerance and time to invest when making investment decisions. Review your personal situation with a professional before planning any gifting or estate planning.
