Why Interest Rates Could Remain Elevated [VIDEO]

The current economic environment is drawing comparisons to the 1970s - an economic era many people aren't in a hurry to revisit.

In the early 70s, oil prices surged following OPEC’s oil embargo, and U.S. budget deficits expanded as government spending increased. Today, oil prices are elevated due to supply concerns, and fiscal deficits are deepening once again.

While the 1970s and today share rising oil prices and budget deficits, the most direct link between the two periods is inflation.  Although the numbers differ, a similar pattern has emerged, as shown in Figure 1:

In the early 1970s, rising fuel prices contributed to the spike in inflation.  More recently, supply chain disruptions related to the 2020 pandemic drove the inflation rate significantly higher. In both instances, the Fed responded by aggressively raising interest rates and successfully subdued inflation (at least initially).

After reigning in inflation in the early 1970's, the Fed was quick to cut short-term interest rates in an effort to counteract the '73-'75 recession - only to inadvertently reignite inflation. By the end of the decade  inflation had climbed to 13.3%. This rapid rise prompted the Fed to raise the federal funds rate to a staggering 20% in an effort to combat runaway prices. The result was back-to-back recessions in the early 1980's.

A  resurgence in inflation, similar to what occurred in the '70s, is a primary risk today.  The fear of a 1970's style rerun and its aftermath explains why the Fed is hesitant to end the current rate tightening cycle.  The Fed is determined to avoid repeating its past errors and the implication is that the Fed may decide to keep interest rates higher for longer. 

In terms of investment strategy, we are factoring in these developments as we look forward. If you would like additional guidance or insight, please schedule a call. 

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