KEYBANK ECONOMIC PERSPECTIVES: IS THE ECONOMY OVER INFLATED?

Major global central banks have long regarded a two percent inflation target as the sacred metric that drives economic policy. That’s true far and wide, from the Bank of Japan to Sweden’s central bank. And in the United States, former Federal reserve chair Ben Bernanke was so committed to a 2 percent inflation target, he enshrined it in official fed policy in 2012. But a decade later, we live in a world that Bernanke could have never predicted. In 2022, the economy is weathering a global pandemic that is becoming endemic, a European military crisis in the Ukraine, soaring fossil fuel prices and an inflation rate that as of January 2022 stood at 7 percent.

Of all those factors, an inflation rate that hasn’t been seen since the early 1980s is key to why the Federal Reserve has signaled its plans for a series of interest rate hikes beginning in the spring of 2022. And those hikes are sure to have a distinct economic impact to both consumers and businesses that rely on loans to help them purchase big-ticket items like cars and furniture. But how did we get here? And how should businesses respond?

“Two years ago, the [Federal Reserve] felt they had to do all they could to ensure that when we went into lockdown the economy would stay face up,” explains KeyBank Chief Investment Officer George Mateyo. The tactic was stimulus. Rates stayed at zero while money was pumped

“Human ingenuity points to long-term growth. Yes, things may slow down but there are going to be very positive tailwinds in the long term. So long as your own finances and balance sheets are in order, it’s not a bad time to be thinking long-term.

into the American monetary system. At the same time the federal government was also aggressively directing stimulus to consumers to the tune of trillions of dollars.

“So, all of this money showed up in bank accounts of people sitting at home with not much to do,” he adds. “They decided it was time to get a new deck or buy a new barbecue or sofa.”

The upshot of the stimulus was that spending took off in the second half of 2020. But as spending increased, companies were also struggling with pandemic labor shortages and shutdowns. There were also shipping delays and supply issues creating a significant mismatch between supply and demand. “That’s a classic economics 101 recipe for inflation,” Mateyo says.

Despite the fact the economy was cooking up inflation, the Federal Reserve opted to maintain stimulus into 2021. But with consumers beginning to call out higher prices, the tactic has shifted – to decrease inflation, demand needs to cool so equilibrium can be achieved.

“The idea is to take the punchbowl away from the party,” Mateyo explains. And the Federal Reserve plans to do just that with a series of interest rate hikes. “Interest rates increase the cost of money,” he continues. “As the cost of money goes up people are likely to borrow less. And historically that’s a pretty good suppressant to growth.”

On the surface, rate hikes would seem to be a real barrier for middle market companies that rely on financing to help consumers buy goods. But Mateyo says that’s not necessarily so. For instance, supply chain shortages have caused inventory issues for car dealerships, some of which need to place customers on waiting lists. And for goods like furniture, the wait time for a new sofa has increased significantly.

“To some extent, demand might come down, but demand has been so extended that it might be time to catch our breath and see production catch up,” Mateyo notes. “We want to see some normalcy. It’s a tricky balancing act because inflation can tip over to into recession.” Finding balance is not easy. There’s a great deal of uncertainty on a tightrope, which is why forecasts of what Federal Reserve rate might look like vary wildly. At the end of 2021, the prevailing thought was that there would be a gradual increase in rates to around 1.5 percent. But now, some analysists predict anywhere from four to eight incremental rate hikes over the course of the year.

Importantly, those forecasts came before the Russian incursion into Ukraine, creating even more economic uncertainty as oil prices soar even higher. Add that to global sanctions on a major country and Mateyo says it’s possible that economic activity might naturally slow. He notes that hesitation might begin to permeate the economy.

“The fog of war has made everyone’s crystal ball cloudy,” he notes.

So, what are business owners to do in uncertain times? Mateyo notes that in general it’s time to be disciplined with inventory. But beyond that, business owners can also take a long-term view and seek out opportunities. “You could look at acquisitions, or other business lines you might want to start,” he says. “But you need to know that we’ll get through this. We have before. Business can still prosper. “Human ingenuity points to long-term growth,” he continues. “Yes, things may slow down but there are going to be very positive tailwinds in the long term. So long as your own finances and balance sheets are in order, it’s not a bad time to be thinking long-term.” n

For more information regarding economic perspectives readers can join George Mateyo and Federal Reserve representatives for a live-streamed discussion on April 21st at 11:00 a.m. PST. Visit key.com/epwebinar to register. To learn more, contact Ryan Ames: 206-343-6852 or Ryan.M.Ames@key.com