Inflation and the spirit of Paul Volcker

  • The U.S. Bureau of Labor Statistics says the 12-month inflation rate hit 8.5%, the highest since 1981.
  • Core inflation excluding food and energy hit a 12-month 6.5% rate, the highest since 1982.
  • Paul Volcker served as Federal Reserve Chairman from 1979 to 1987.
The Federal Reserve Building in downtown Washington DC, USA at night.

At the Museum of American Finance, a 2 x 4 piece of wood mailed to then Fed Chair Paul Volcker by builders and contractors in the early 1980s features prominently. The peculiar package was meant to be a reminder to the – Chair that he was destroying the economy with his strategy of aggressive interest rate hikes (in May 1981, Fed Funds – the Federal Reserve target rate – were raised to close to 20%) meant to bring inflation under control. 

Inflation had been rampant in the late 1970s, as the 1973 Yom Kippur war had caused a spike in oil prices and political pressure on the Federal Reserve – thwarted any effort to fight it. -, President Jimmy Carter appointed Paul Volcker as Fed Chair in 1979, with inflation at 9.3% (it would go to 11% and then 13% in the two subsequent years). That move was among the issues that cost Carter re-election. 

Despite the colorful protest, Volcker stayed the course and was vindicated. In 1983 – four years after his appointment as Fed Chair and with rates at 9% – housing starts rebounded strongly, reaching 1.7 million. That is approximately 100,000 more starts than last year – when rates were at 0. Residential real estate continued to perform well in 1984 when short-term rates again increased to 11%. 

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This quick flashback may help investors put the recent release of the March consumer price index (CPI) inflation numbers this morning – with YoY headline at 8.5% and YoY core (excluding food and energy) at 6.5% – into perspective. While the number seems high, and while the latest generation of investors has never experienced a highly inflationary environment – this is far from being unprecedented. 

As we anticipated in our “Week Ahead” preview last weekend, today’s number is relevant as it may push the Federal Reserve to hike rates faster than expected. An upside surprise in inflation – such as today’s number – does not generally impact the Fed’s reaction function, but some recent investment bank research has pointed to the potential for a higher than expected reading to sway the Fed into opting for a 50 basis point hike rather than a 25 basis point increase at its next meeting in May. A faster pace of hikes can lead to a recession, all things being equal. 

While originally supply-driven – with commodities and supply-chain disruptions being its main culprits – US inflation appears to have percolated to wages, and thus demand, which may require longer to tame. And some of the factors behind this year-long rapid increase in prices are still there, with the unwelcome addition of a war in Europe that exacerbated supply-chain issues in the largest US trading partner. 

Hedging against inflation may be a complex exercise for most investors. Traditional inflation offsetting investments include value stocks – public equities that are less sensitive to interest rate increases – and, among alternative investments, private equity, and real estate. 

All that said, there are also signals that inflation may have peaked, and that the right monetary policy decisions may bring it under control in the next few months. 

Our Yieldstreet investment teams will continue to closely follow the evolving inflation outlook in order to calibrate investment decisions accordingly. In highly volatile markets, alternative assets – which can be less sensitive to public market moves – may offer an opportunity for diversification, while longer maturities can help investors look through short-term volatility. 

Learn more about the ways Yieldstreet can help diversify and grow your portfolio

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