By Daniel McGarvey, Portfolio Analyst
With inflation exceeding 40-year highs, the topic has become both a source of grief for consumers and a political lightning rod. Many politicians blame inflation on corporate greed, and many others blame it on President Biden’s response to COVID and the war in Ukraine, but we find that the most objective cause has simply been too much money creation. After the pandemic began, the federal government almost indiscriminately sent out massive stimulus packages that pumped over $4 trillion into the economy, putting money in the hands of consumers who were at the same time restricted from going out and spending it.
There were four attempted stimulus packages (of which three were approved by Congress, some through budget reconciliation), and arguably only one and a half of them were needed. Stimulus was even sent out to businesses experiencing record profits, without a check on whether they really needed it. This infusion of cash into the economy was also coupled with the Federal Reserve lowering interest rates to almost 0%, which helped stimulate business activity but may have made borrowing too cheap and big purchases too attractive. These policies caused money supply and the deficit to soar, as evidenced by the ratio of federal debt to GDP reaching all-time highs in 2020 (see chart below).
Of course, there have been other contributing factors like global supply chain disruptions, the invasion of Ukraine, COVID and worker shortages, but we believe the major culprits have been government stimulus and loose monetary policy. These policies helped boost returns over the last two years, but now we face the consequences. If the Build Back Better plan had also gone through as proposed, the inflation situation would likely be even worse.
It now remains to be seen whether the Federal Reserve can raise rates enough to fight inflation without causing a recession, and it has its work cut out for it. However, it is possible we have seen peak inflation at this point. While some sectors of the economy might seem to be in recession already, others might perform well going forward, and we are trying to manage many of our strategies with the flexibility to focus on these sectors.
The S&P 500 returned 0.23% in May and -12.79% year-to-date amid continued uncertainty regarding inflation, rate hikes and geopolitical conflict. Additionally, some major companies reported earnings misses and poor guidance, which implied inflation is weighing on profits. The 10 Year Treasury rate peaked at 3.2% before coming back down and ending the month at 2.86%, and the yield curve remained relatively flat. The Bloomberg US Aggregate Index had its first positive month of the year with 0.76% returns, and high-yield spreads widened from 3.97% to 4.19%. Oil prices have continued to climb, with WTI crude oil rising from around $77 per barrel to $115.