The words “inflation” and “interest rates” are being used interchangeably these days. For example, market analysts say things like, “As we enter into this inflationary environment it affects asset prices.”. But that is not accurate. Inflation has not yet proved out. What analyst should say is, “As we enter into a higher interest rate environment, it affects asset prices.”.
Reflation, or growth, is not “inflation”. (Let me digress for a second to mention that “inflation” has become a pejorative. Some inflation is good. Such as when you get a raise. But back to my point.) Sales and prices and wages can rise without an inflation scare being necessary, as long as the numbers stay in acceptable ranges.
Just to be clear, stocks can rise in an inflationary environment. But not in a higher interest rate environment that lacks inflation. Again, two different things.
Here are 6 reasons, other than inflation (well, other than housing inflation), why interest rates are rising:
- As the result of quantitative tightening to reel-in a housing bubble;
- as the result of Fed rate hikes to reel-in a housing bubble;
- due to corporations selling short term bonds to move that capital into investments that will benefit from new tax laws;
- due to the U.S. government financing its spending;
- due to investors concern about falling bond prices and growing debt and deficits;
- due to foreign nations’ concerns about falling bond prices and growing debt and deficits.
Interest rates rising without inflation is a negative because it indicates fear on the part of the Fed that there are asset bubbles (equities and housing), especially where FOMC minutes indicate no concern for wage or consumer price inflation. It also means that the government is funding its spending and debt with higher interest rates. It also means that bond investors are finding better places for their fixed income investments. Finally, it means that consumer and homebuyers’ borrowing costs are rising- while their incomes aren’t.
I’m not yet sure that inflation is in the mix, but I don’t believe it to be the case. We will see in the March employment report and the next PCE report. Oil prices are all over the map (speaking both geographically and figuratively).
Whether tax cuts for consumers and tax incentives for businesses to spend offset the growing debt expenses for consumers and businesses remains to be seen. But as businesses spend on cap-ex, input costs, such as oil, may rise. So, again, let’s hope incomes and tax cuts offset the additional costs to consumers and businesses.
Some interpret the recent employment and CPI and PPI reports as inflationary. But wage growth was weak, the CPI was no higher than the prior month, and the PPI probably reflected prices rising from the weaker dollar, rather than growing demand. Thus, these rises are potentially transitory, and not reflective of growth. They also could reflect fancy accounting by the government to establish inflation concerns as cover to raise interest rates to control a housing bubble.
The weakening dollar is not necessarily something higher interest rates can cure. Especially if fiscal stimulus and rising debt and deficits are concerns. If rates go too high to protect the dollar, investors’ worst fear, recession, would be realized.
If it were not for tax cuts, we would already be sinking fast. I’m confident that the White House and Congress coordinated the tax cuts to accompany the rate hikes and quantitative tightening in hopes of a soft landing for assets. Let’s hope the tax cuts pan-out to be a net positive rather than a debt drag for the nation and a big knock on the dollar.