How to deal with rising rates and inflation

Important information has arrived in recent days, but it does nothing to dispel the fog that shrouds the markets and the economy.

Is the economy teetering into a recession? Is inflation under control?

Clear answers are important for anyone who has a job or hopes to get one, anyone with bills to pay, a house to buy or sell, an apartment to rent, a loan to make or repay, or investments. predictable. Really, for just about everyone.

But no one has those answers.

It would be better, of course, if there was more clarity, but that simply does not exist. Prudent people will have to operate on two tracks: prepare for short-term problems, while investing for the long term.

First, on Wednesday, the Federal Reserve announced it was raising short-term interest rates by 0.75 percentage points, bringing the federal funds rate into the 2.25-2.50% range – a strong up from almost zero in early March.

Then on Thursday, the Commerce Department reported that economic output, as measured by gross domestic product, fell in the second quarter at a seasonally-adjusted annual rate of 0.9%. This is the second consecutive quarterly decline. The new data will be revised, and doesn’t mean the economy is in a recession, but even so, this report has sparked a lot of twist.

Jerome H. Powell, the chairman of the Federal Reserve, said at a press conference on Wednesday that the Fed deliberately “slowed down the economy” to curb inflation. But, for what it’s worth, Powell said he doesn’t believe the economy is in a recession, not yet. Worksfor example, are still numerous.

As for where things end up later this year or in 2023, he wouldn’t even try to make a firm prediction. The Fed will pay close attention to new information as it comes in, he said, and soon there was.

Two Democratic senators, Joe Manchin III of West Virginia and Chuck Schumer, the majority leader of New York, announced that they had reached a sprawling agreement on climate and energy programs, health care subsidies and drugs prescription, taxes and, probably, much more. They call it the Cut Inflation Act of 2022 because over a 10-year period, tax increases would exceed spending. But the details are sketchy and the bill’s chances are uncertain.

Read all this news, by all means. Then proceed with caution.

There is considerable risk right now, although we limit ourselves to issues that directly affect the US economy and markets – and, most likely, your personal finances.

At the top of my list is inflation. Mounting evidence of runaway inflation shocked consumers and rocked the political landscape.

The last time inflation was this high, Ronald Reagan was president and Paul Volcker was chairman of the Federal Reserve. If you weren’t there at the time, consider that Mr. Volcker’s primary mission was to “break the back of inflation.” Mr. Powell has made it his mission now.

Currently, oil and gas prices have come down somewhat, but they remain high. The same is true for many other things, such as home and restaurant food, clothing, new and used cars, apartment rents, and house prices.

Mr. Powell indicated on Wednesday that, for now, he expects the Fed to raise the fed funds rate further: to 3.5% by the end of this year, and possibly by a extra half point at the start of 2023.

Inflation and recession are unfortunately linked.

This is because the Fed only has blunt instruments to control inflation: interest rate hikes, sale of securities in its $8.9 trillion portfolio and signaling its intentions with what it calls “forward guidance”. These metrics influence markets and, ultimately, countless buying and daily spending decisions. The Fed uses its tools to incentivize individuals and businesses to demand less for goods and services. Mr Powell says he hopes to give enough “slack” to the economy for inflation to cool.

The problem is that while the Fed can influence demand, it has no control over the supply of goods and services.

The pandemic and the war in Ukraine have created many shortages and bottlenecks. Yet there are signs that they are already easing.

The Baltic Dry Index, which tracks global shipping prices, has fallen 40% since its peak in May. And surveys of the economies of the United States, mainland Europe, Britain and Japan show a sharp drop in “lead times”, as well as stockpiles.

With business activity rapidly slowing, there’s already been a “sea change” in the economy, said Chris Williamson, chief economist for S&P Global Market Intelligence, which conducts the surveys.

“If central bankers keep raising interest rates,” he said in an interview, “policymakers have to do it with their eyes wide open. Because based on that data, you’re going to create a hell of a recession if you keep going.

The National Bureau of Economic Research, which decides whether a recession has actually occurred, took 15 months declare the end of the last. He uses as much time as it takes to be certain while looking back, because he can’t get it right in the present tense. Guesses aside, I doubt anyone can do that.

On June 9, 2008, for example – in the midst of what we now know to be the longest and deepest recession since World War II – Ben S. Bernankethe chairman of the Fed, said he thought the conditions were to improve.

“The risk that the economy has entered a substantial downturn appears to have diminished over the last month or so,” he said. In reality, the housing market was already weakening and the entire financial system and economy would soon collapse.

So we won’t really know if we’re in a recession soon enough to make a difference. Yet we will know when times get tough. At this point, it may be too late to prepare for it if you haven’t already.

Right now, if you don’t already have a comfortable cash reserve, save some money so you can pay your bills. Above all, avoid revolving credit card debt. The average rate, 17.25% and rising, is already penalizing.

Take advantage of rising interest rates for your savings. For example, money market fund rates lag Fed rate hikes by about a month. They are now well above 1%, and in about a month, standard money market fund rates should be above 2%. Certificates of deposit, short-term treasury bills, and I bonds are good options.

Next, invest for the long term. Although stocks and bonds have performed poorly this year, the outlook has improved considerably.

David Rosenberg, chief economist of his own company, Research Rosenberg, has been warning since winter that a recession is approaching. He is therefore bullish on Treasury bonds. “If there’s a recession, you’ll want to hold them,” he said.

I am agnostic on the question of the recession. Not knowing where things are going, I always hold a mix of stocks and bonds and use cheap index funds to do so. Will the equity bear market end? Yes, if there is no recession. But if there is a deep one, stocks could take even more. Still, for those with long horizons – a decade or more – buying stocks regularly, through broad index funds, is probably a good bet.

Vanguard says the blows the markets have taken this year bode well. “Expected long-term stock and bond yields have improved because prices are so much lower,” said Andrew Patterson, senior international economist at Vanguard.

Count on unpredictable markets. Learn to live with them by developing a long-term savings and investment plan. I’ll come back with more suggestions on how to do this.

Once you’ve put your plan into action, try to forget about it for a while. Hopefully, you’ll find that you’ve protected yourself when the next disturbing news arrives.

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