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We keep hearing about the inflation problem and with good reason. Inflation has hit 7%, the highest level we’ve seen in 40 years, and it’s led Federal Reserve Chair Jerome Powell to take major criticism as he looks to get it under control. Stocks rebounded a bit after shedding 11% since the start of 2022, but some worry that this is just a short-term bit of good news before the markets resume their free fall.
The Fed has already suggested, back in its December meeting, that reducing inflation is going to be a priority. How will it do that? First, it will stop adding more money to the system. This is big, because the Federal Reserve has poured a lot of money into the system the past two years to keep the economy afloat during the pandemic.
We more than doubled the amount of money in circulation, in the space of what was a little bit less than two years. Well guess what happens when you push that much more money out the door? You’re gonna put upward pressure on inflation. And indeed we did. Another way to think about it is to look back to when we started this process of adding money, which was after the Great Recession.
Back in 2008, we had just $900 billion in terms of money out there in circulation. So we have almost 10 times as much money circulating out there…on the Fed balance sheet, as we had in 2008, which really wasn’t that far ago. Ten times as much.
The Fed will almost certainly raise interest rates to fight inflation. We may see 3 to 4 rate hikes in 2022, because interest rates are so low right now. That still may not do too much to slow inflation.
Stock market investors need to focus on the Fed’s plan to shrink the money that’s out there. By doing that, it will mean less money to buy stocks. Combine all of that with the fact that the Fed plans to buy fewer bonds — because it’s putting less money out there — and investors are likely to put their money in safer investments like bonds and sell their stocks.
Considering stocks are at a historically high level right now, we should brace for the inevitable decline, and plan accordingly.
