US Inflation Spikes, Government Spending Spree continues, Fed maintains Zero Interest Rates and Markets

By Musabbir Mazhar

Inflation numbers reported on November 10, 2021 in US went up by 6.2% in the last 12 months with Energy up 30% and Used Cars and Trucks up 26.4%! To put into perspective, that’s the largest jump since 1990.

While that inflation number seems high at first sight, it should not be surprising given that the US Government spent about $3.4 Trillion in response to Covid19 in the last 2 years alone and much more to come, while the Fed has been maintaining accommodative monetary policy. In March 2020, a $2.2 Trillion economic stimulus, the CARES Act, was passed by congress under then President Donald Trump. In March 2021, another $1.9 Trillion economic stimulus, American Rescue Plan Act of 2021, was passed by Congress under current President Joe Biden. Well, as if that was not enough, in November 6, 2021, a $1 Trillion Infrastructure Investment and Jobs Act was passed by congress which is to be signed into law on November 15, 2021.

In my opinion, given that we have been recovering from the pandemic with economic stimulus funds, with large portion of population vaccinated, while being able to keep the interest rates at near 0%, the government is overdoing it with the Infrastructure bill and definitely will put more uncertainty filled inflationary pressures into the economy.

If interest rate in the economy is driven by real GDP growth, it’s good for businesses versus if interest rate is driven by inflation. Let me explain simply. When there is real GDP growth, due to higher demand, business can increase revenue growth through price increases while being at same cost levels thus increasing Operating Profit Margins. When there is inflation, companies are really trying to increase prices due to cost increases and the operating profit margins would be flat for companies that can pass along a price increase, and margins will be lower for companies that cannot pass along price increases. Ultimately all businesses in the economy are owned by individuals and hence that trickles down to households.

One caution I would sound is that the US public debt is at record highs of 125% of GDP while the federal interest payments to service that debt as a percentage of GDP is only at 1.5% which is pretty low comparing to historical levels and that is just due to low current interest rates despite ballooning debt levels in the last 2 years. That picture would definitely change if interest rates rise and not in favor of painting any better picture for the US Government debt.

To combat current outlook of higher inflation and high debt levels, you would have to lower spending which at the current administration does not look like would do, or you would have to increase interest rates in the economy or you would have to increase tax rates, or perhaps a combination – time would tell what transpires.

The S&P 500 ended the week at all time highs at 4,682.85, up over 29% in the last 1 year. The big tech companies (Google, Apple, Facebook (now Meta), Microsoft) reported their recent quarterly earnings release and I thought they just re-iterated what absolute cash generating machines they are. Apple did a staggering $85 Billion in stock buybacks in the last 1 year alone. Facebook renamed itself to Meta with the backdrop of lots of negative press and announced their big push to the metaverse; Microsoft followed with announcement of their push to metaverse with Microsoft teams. I think it would be an interesting space to see how developers and users take the metaverse as it really develops and evolves and how the companies are able to monetize it either through products or advertising.