Inflation: Multi-Factor Problem May Require Multiple Solutions

Knocking down inflation may require a multi-pronged and painful approach.

By
Samuel Park
Director of Fundamental Research, Pacific Life Fund Advisors
&
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Key Takeaways

  • Controlling inflation has been especially difficult in a pandemic-driven world.
  • The Federal Reserve’s increasingly hawkish tone is designed to dampen fears of a continued rise in inflation.
  • Taming inflation will likely be the result of a multi-pronged solution, including interest-rate hikes, quantitative tightening, controlling COVID and repaired supply chains.

Inflation has been running at its fastest pace in four decades, and it’s become a multi-factor problem that will require multi-solutions––a herculean job that threatens to overwhelm the Federal Reserve. The sticky inflation has been a result of many fundamental and geopolitical disruptions, including supply-chain woes, elevated oil prices, shifting consumer demands, and now the Ukraine-Russia war.

The question everyone has been asking is how to properly knock down inflation, especially in a pandemic-driven world. The pandemic led to business slowdowns and shutdowns, leading to a shortage of goods that people want to buy. Next, transporting those goods turned out to be complicated by the lack of infrastructure investments. This underinvestment has been evident by the slow progress in the supply-chain recovery, which has been a major reason for this stubborn inflation that few had predicted.

Energy and gas prices have also fueled price increases. Even before the Ukraine-Russia war, energy and gas prices were on the rise and becoming a global economic threat. Now, sanctions on Russia have further driven up prices on oil prices and other commodities, including wheat.

Finally, China’s heavy-handed COVID-19 strategies have been an important additional factor to global inflation.

So, what has kept the economy stable? Low unemployment, which suggests people still have money to spend. But again, this has led to more inflation since the consumers have had only a few places to spend their savings.

With so many factors pushing prices higher, there is no simple solution to fix today’s rising inflation. The Federal Reserve has started its interest-rate hike regime, and the balance-sheet quantitative tightening is expected to be not far behind.

Raising rates would make borrowing more expensive, which means less spending and less demand for large ticket items such as houses and cars. The problem with addressing inflation with rate hikes is that it takes time before these hikes are felt through the broader economy.

Recently, more Fed members have spoken with a hawkish tone to, in part, dampen fear of continued increases in inflation. When everyone anticipates a rise in inflation, businesses and workers tend to charge more, self-perpetuating the cycle. The idea is to reduce this expectation of future inflation before it spirals out of control as it did in the 1970s. But a danger in this hawkish strategy is that it could lead to the Fed moving too aggressively on rates, which could risk the chances of a soft-landing where the economy and inflation are slowed to a manageable pace.

While the Fed tries to adjust inflation expectations, there is very little it or the White House can do about price increases caused by supply-chain disruptions, COVID variants and a war in Ukraine. As we said, today's inflation has been caused by multiple factors and will require a multi-pronged and potentially painful solution, which will likely include raising interest rates, quantitative tightening, fixing supply chains, getting COVID under better control, and, hopefully, ending the Russia-Ukraine War.

Those are a lot of moving parts. In the coming months, it will be interesting to see if they will work together to bring down inflation while keeping the economy healthy.

Definitions

Quantitative tightening (QT) or quantitative hiking is a contractionary monetary policy applied by a central bank to decrease the amount of liquidity within the economy.

Pacific Life Fund Advisors LLC is the manager of the Pacific Funds Portfolio Optimization Funds.

The views in this commentary are as of the publication date and are presented for informational purposes only. These views should not be construed as investment advice, an endorsement of any security, mutual fund, sector or index, or to predict performance of any investment. Any forward-looking statements are not guaranteed. All material is compiled from sources believed to be reliable, but accuracy cannot be guaranteed. The opinions expressed herein are subject to change without notice as market and other conditions warrant.

Pacific Life Insurance Company is the administrator for Pacific Funds. It is not a fiduciary and therefore does not give advice or make recommendations regarding insurance or investment products.

Investors should consider a fund's investment goal, risks, charges, and expenses carefully before investing. The prospectus and/or summary prospectus contains this and other information and should be read carefully before investing. The prospectus can be obtained by visiting PacificFunds.com.

Pacific Funds is a registered service mark of Pacific Life Insurance Company ("Pacific Life"). All third-party trademarks referenced by Pacific Life, such as S&P, belong to their respective owners.

Pacific Funds are distributed by Pacific Select Distributors, LLC (member FINRA & SIPC), a subsidiary of Pacific Life Insurance Company (Newport Beach, CA), and are available through licensed third parties. Pacific Funds refers to Pacific Funds Series Trust.

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