Bracing for Impact: Assessing the Potential for a Second Wave of Inflation

In the late 1970’s the United States experienced what was called a second mountain of inflation. From 1978-1980 inflation rates in the United States surged to new highs as a continuation of the inflationary pressures that had been building throughout the decade.

Several factors contributed to this second wave of inflation:  Oil Price Shocks from The OPEC oil embargo of 1973-1974,  Wage-Price Spirals which fanned the flame to more inflation because workers demanded higher wages to keep up with inflation, resulting in businesses raising prices to cover the increased labor costs. A third cause of inflation was Monetary Policy: The Fed pursued a policy of monetary accommodation in the early 1970s, which led to an expansion of the money supply and higher inflation. And Finally Supply Constraints lead to shortages and higher prices for many goods.

The combination of these factors led to a rapid acceleration of inflation in the late 1970s and early 1980s. In response, the Federal Reserve under Chairman Paul Volcker implemented tight monetary policies, raising interest rates to combat inflation. This policy, while effective in reducing inflation, also contributed to a period of economic recession in the early 1980s.

Could this scenario happen again? Take a look at this chart for some insight.

Inflation today is influenced by factors such as supply chain disruptions, increased consumer demand, labor shortages, rising wages, increased consumer demand and the results of massive monetary stimulus during the COVID pandemic. With the exception of the oil embargo todays factors that are influencing inflationary pressures sound pretty similar to the factors we experienced in the 1970’s.

Since the Fed turned dovish in December, financial conditions have eased dramatically, with the S&P 500 reaching all-time highs, credit spreads tightening, IPO activity picking up, and M&A activity picking up. As a result, consumer spending is currently getting a strong boost from record-high stock prices, high home prices, and high cash flows for investors in fixed income such as bonds or bank CD’s. The bottom line is that a dovish Fed, one who continues to lower interest rates and  giving the green light to investors too soon could result in a second mountain in inflation.

Let this chart speak for itself. Where do you think inflation is headed in the next year?

As always, we will keep our eye on the economic conditions and manage your portfolio accordingly.  Thank you for the trust that you have placed ion the Simmons Capital Group team.