The Fed’s target of 2% annual inflation, based on personal consumption expenditures (PCE), hit 2% in May 2018, the first time in over six years. PCE usually trends 0.3 to 0.5% lower than the more commonly used inflation indicator known as the Consumer Price Index, or CPI. The main difference between the CPI and the PCE value is that CPI is based on a survey of what consumers are buying, while PCE is based on a survey of what businesses are selling.
The Fed has been on a course to “normalize” interest rates and the balance sheet since late last year. The prime rate has increased from almost zero to nearly 2% over the past few years. However, it needs to increase further to get to levels that are considered consistent with historical averages. Another couple of reasons to increase interest rates are: 1) to keep inflation in check, and 2) to have a higher level to use as a cushion, in the event of a recession.
It is difficult to write about a subject as bland and undynamic as inflation or interest rates, because it is a subject and a cycle that moves like a glacier. However, it is also as impactful as a glacier. And when inflation starts moving in an upward direction it is very hard to stop. In November 2017, I wrote a blog facetiously titled “Will inflation remain at or below 2% forever?” Included in that blog is a graphic that shows the curve of inflation from 1982 to 2017. The point being, that the left half of the U shape coming down will be reflected in the opposite effect of the U curve going up from now until 2036.
Prepare for the coming inflation. Eliminate any and all variable interest rate loans or mortgages in your life. Reduce you bond holdings and only purchase TIPS (inflation protected) treasuries. Protect yourself from increasing energy costs by going solar and consider investing in alternative energy transportation. Forewarned is forearmed.