Wednesday, September 28, 2022
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How to Cope With Rising Rates and Inflation

Important pieces of information arrived over the last few days, but they do nothing to clear away the fog blanketing the markets and the economy.

Is the economy lurching into a recession? Is inflation coming 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 to worry about. Really, for just about everyone.

But nobody has those answers.

It would be better, obviously, if there were more clarity, but it simply does not exist. Prudent people will need operate on two tracks: preparing for short-term trouble, while investing for the long term.

First, on Wednesday, the Federal Reserve announced that it was increasing short-term interest rates by 0.75 percentage points, bringing the federal funds rate to the 2.25 to 2.50 percent range — a sharp rise from nearly zero at the beginning of March.

Then, on Thursday, the Commerce Department announced that economic output, as measured by gross domestic product, fell in the second quarter at a seasonally adjusted annual rate of 0.9 percent. That was the second consecutive quarterly decline. The new data will be revised, and does not mean that the economy is in a recession, but even so, this report prompted considerable hand-wringing.

Jerome H. Powell, the Federal Reserve chair, said in a news conference on Wednesday that the Fed had been deliberately “slowing the economy” to curb inflation. But, for what it’s worth, Mr. Powell said he did not believe the economy was in a recession, not yet anyway. Jobs, for instance, are still plentiful.

As for where things will 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 arrives, he said, and a short time later, there was some.

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

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

There is considerable risk right now, even if we limit ourselves to the issues that directly affect the U.S. economy and markets — and, quite possibly, your personal finances.

At the top of my list is inflation. Mounting evidence of runaway inflation has been shocking consumers and roiling the political landscape.

The last time inflation was this hot, Ronald Reagan was president and Paul Volcker was the chair of the Federal Reserve. If you weren’t around then, consider that Mr. Volcker’s main mission was “breaking the back of inflation.” Mr. Powell has made that his mission now.

At the moment, oil and gas prices have eased somewhat but are still high. So are a lot of other things, like food at home and at restaurants, clothing, used and new cars, apartment rents and home prices.

Mr. Powell indicated on Wednesday that, at the moment, he expected that the Fed would elevate the federal funds rate further: to 3.5 percent by the end of this year, and perhaps by another half a point early in 2023.

Inflation and recession are connected, unfortunately.

That’s because the Fed possesses only blunt instruments for taming inflation: raising interest rates, selling off securities in its $8.9 trillion portfolio and signaling its intentions with what it calls “forward guidance.” These measures influence the markets and, ultimately, countless daily buying and spending decisions. The Fed is using its tools to induce people and businesses to demand less in goods and services. Mr. Powell says he hopes to give the economy enough “slack” so that inflation will cool down.

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

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

The Baltic Dry Index, which tracks global shipping prices, has fallen 40 percent since its peak in May. And surveys of the economies of the United States, continental Europe, Britain and Japan show sharp declines in “supply lead times,” as well as in inventory buildups.

With business activity rapidly slowing, there has already been an economic “sea change,” said Chris Williamson, chief business economist for S&P Global Market Intelligence, which conducts these surveys.

“If the central bankers keep raising interest rates,” he said in an interview, “policymakers need to do this with eyes wide open. Because on the basis of this data, you will create quite a recession if you carry on.”

The National Bureau of Economic Research, which decides whether a recession has actually taken place, took 15 months to declare the end of the last one. It uses as much time as it needs to be certain while looking backward, because it can’t get it right in the present tense. Guesses aside, I doubt that anyone can.

On June 9, 2008, for example — in the middle of what we know now was the longest and deepest recession since World War II — Ben S. Bernanke, the Fed chair, said he thought conditions were improving.

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

So we won’t really know if we are in a recession soon enough for it to make a difference. Yet we will know when times feel tough. By that point, it may be too late to make preparations for it if you haven’t done so already.

Right now, if you don’t already have a comfortable cash reserve, conserve money so you will be able to pay your bills. Above all else, avoid revolving credit card debt. The average rate, 17.25 percent and rising, is already punishing.

Take advantage of rising rates for your savings. For example, money market fund rates lag about a month behind Fed rate increases. They are now well above 1 percent, and, a month or so from now, standard money market fund rates should be above 2 percent. Certificates of deposit, short-term Treasurys and I bonds are good options.

Then, invest long term. While both stocks and bonds have performed badly this year, the outlook has improved considerably.

David Rosenberg, chief economist of his own firm, Rosenberg Research, has warned since the winter that a recession is coming. So he is bullish on Treasury bonds. “If there is a recession, you will want to be holding them,” he said.

I’m agnostic on the recession question. Not knowing where things are headed, I always hold a mix of stocks and bonds and use cheap index funds to do it. Will the bear market in stocks end? Yes, if there’s no recession. But if there is a deep one, stocks could take a further pounding. Nonetheless, for those with long horizons — a decade or more — buying stocks steadily, through broad index funds, is likely to be a good bet.

Vanguard says the pummeling that the markets have taken this year augurs well. “Long-term expected returns in both stocks and bonds have improved because prices are so much lower,” Andrew Patterson, senior international economist at Vanguard, said.

Count on unpredictable markets. Learn to live with them by putting together a long-term plan for savings and investment. I’ll return with more suggestions on how to do that.

Once you set your plan in motion, try to forget about it for a while. With a little luck, you will find that you have protected yourself when the next unsettling news arrives.

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