Business leaders, economists and politicians around the world have spent a lot of time searching for ways to solve supply chain disruptions that are hampering growth and prosperity for corporations and consumers alike. Some business experts, such as Harry G. Broadman of the Berkeley Research Group, contend that these disruptions predate the COVID-19 pandemic.
In a survey of 2,000 global CEOs that was released this past January, professional-services company EY reported that 87% of respondents have witnessed significant price increases for labor, energy and raw materials since the onset of the pandemic. One in five executives said that the pandemic had “fundamentally reshaped our industry for the worse” while 79% had adjusted their supply chain operations to reduce costs, manage geopolitical risks or strengthen business resiliency.
Two years into the global health crisis, pent-up consumer demand is exacerbating the ability to cheaply produce goods and deliver services. In turn, inflation has become a household name.
The annual inflation rate in 2019, prior to the pandemic, was 1.8%.As of this past January, this figure had quadrupled to reach a 40-year high mark of 7.5%. Many types of services and household goods were vastly more expensive on a year-over-year basis — including such items as meat (up 12.2%), natural gas (up 23.9%) and used vehicles (up 40.5%), the U.S. Department of Labor reported.
The Fed is going to have a very difficult time unwinding [inflation]. Why? Because it’s getting embedded.
Ed Pinto, director, American Enterprise Institute Housing Center
This news caused immediate distress for U.S. stocks. Three major indexes, including the S&P 500, dropped by at least 140 basis points on a single day this past February. The long-term effects, of course, could be much more severe. The Wall Street Journal warned that the Federal Reserve has previously struggled to tamp down inflation without harming the economy. In the early 1980s, with inflation running in double digits, the Fed implemented stop-go policies under the leadership of Paul Volcker. A 16-month recession ensued, although the tightened monetary supply led to inflation easing to less than 4% by 1983.
Fannie Mae chief economist Doug Duncan says that today’s financial institutions are in uncharted territory. Few people in the mortgage industry remember what it’s like to manage in an environment with rising inflation. The early ‘80s provide an example of what is likely to happen. As inflation spiked, so did mortgage rates, which rose from an annual average of 13.7% in 1980 to 16.6% in 1981, according to Freddie Mac data. And although home prices didn’t decline, the number of homes sold dropped significantly.
“The directional influence of interest rates is on (sales) activity levels and price is indirectly impacted,” Duncan says. “If rates rise and demand falls so that it looks like we have an increasing amount of supply, but it’s just that sales slowed, house prices may well slow, but it’s a result of the reduction in demand.”
With the benchmark rate sitting at a range of 0% to 0.25% since March 2020, the Fed was expected to begin a series of increases at its meeting this past month. It’s anyone’s guess how fast and how much rates will rise going forward, but economists agree that actions must occur. Bank of America analysts, for instance, forecast a total of 11 quarter-point hikes by the end of 2023. And James Bullard, president of the St. Louis Fed, called for a full percentage-point increase by this July.
For Ed Pinto, director of the American Enterprise Institute Housing Center, Fed policy should’ve started shifting many months ago. He notes the inflationary impacts on everything from apartment rents (which reached record-high annualized growth of 13.9% at the start of this year, according to Yardi Matrix) to auto insurance premiums (which many companies are reportedly raising by 6% or more).
“The Fed is going to have a very difficult time unwinding it. Why? Because it’s getting embedded,” Pinto says. “All of that is going to keep inflation from being transitory. I’m not suggesting that inflation is going to 10% or 8%, and I’m not even suggesting that it’s going to necessarily stay at 7%. What I believe is, it’s not going back to 2% anytime soon.”
Prognosticators such as Fannie Mae expect inflation to cause a significant pullback in home-price growth. This past February, the government-sponsored enterprise forecast price increases of 7.6% in 2022 and 3.3% in 2023, based solely on purchases made through the Federal Housing Finance Agency. Those figures are much lower than the record-setting growth of 17.3% last year.
In the meantime, however, prospective buyers are showing displeasure with the state of the housing market. A record-low 25% of respondents to Fannie Mae’s January 2022 national housing survey felt that it’s a good time to buy a home.
“It’s just an expression by them that they recognize this very outsized appreciation in house prices,” Duncan says. “And it’s frustrating. For some of them, that combination of increase in prices and interest rates will push them off the board from an affordability perspective.”
“[The Fed is] really between a rock and a hard place,” Pinto says. “They need to snuff out house-price inflation that’s rampant. They also need to snuff out goods-and-services inflation, which is also rampant, and at the same time, not crater the economy.” ●
