Weekly Comment - February 16, 2021

Feb 16, 2021 | Nick Foglietta


Raising interest rates in the present climate would halt inflation in its tracks.

“Good News for the Middle Class”

This week we explore how the government debt increases, coupled with the COVID economy has impacted average people, and what it might mean for investors as we move forward.

The chart below shows the net worth of the bottom 50% of Americans over the longer term.

That is a pretty healthy increase since the bottom of the last recession. What is really impressive is the trend shown in the chart below.

The American middle class consumer is in a much better place to both, consume and take on more debt again.

The chart below shows that demand has jumped up since the huge decline triggered by the COVID lockdowns.

The sources of this increase are:

  • Pent up demand
  • The improvement in the middle class balance sheet allowing for more flexibility to spend.
  • The restocking of inventory by retailers unable to order products during COVID lockdowns.

Food price inflation has also been ramping higher. Food inflation is the most socially destabilizing type of inflation since everybody has to eat, regardless of how much money they have to spend on food. Obviously, food inflation hits a home with a monthly budget of $1,500 per month much harder than the home with a monthly budget of $5,000.

How about the cost of shipping all that stuff from China to North America?

As restocking takes place, retailers are scrambling to access the remaining capacity on container ships.

Those are large increases to be absorbed by the producer or retailer alone.

The next chart is the one I want to spend some time on. In my opinion, it holds the keys to the next few years and what happens to interest rates.

Let me quickly summarize what has been shown above.

We already know the top 25% of Americans have done very well during the pandemic in terms of net worth increasing. The first two charts show the financial health for the bottom 50% has improved markedly too.

There is pent up demand and an increased capacity for spending in the socio-economic demographic most likely to go out there and use it.

Inflation rates are already accelerating and will likely continue to go higher given the facts listed above.

The chart below shows the year over year increase in commodity prices in blue and the manufacturing price index increase in red. Those are some steep increases in manufacturing costs and those will be passed on to consumers.

How these moving pieces to the puzzle work themselves out remains to be seen. In my mind, I struggle to see how the central banks even come close to raising interest rates enough to combat the more abundant seeds of inflation germinating all around us.

Nominal interest minus inflation = Real interest rate

(Example: 1.1% bond – 2.8% inflation = -1.7% real interest rate)

What that means is the even though “nominal” interest rates are rising, “real” (nominal minus inflation) interest rates are not budging. As long as interest rates remain below the inflation rate, people will feel pressure to keep speculating in stocks and real estate. The greater the negative gap between the interest rate and inflation, the greater the urge to not hold cash becomes.


The improvement in the balance sheet of the American (and likely Canadian) middle class during the COVID year will likely lead to a spree in spending because: (1) Pent up demand, and (2) more flexibility to borrow.

The challenge is that inflation is already taking off to the upside even before everything opens up again and people really start to spend due to retailer inventory restocking.

Inflation flows like a river while it grows in intensity. The path this river follows has been magnified by central bank actions over the past two decades. Inflation progresses roughly in this manner:

Stock and real estate inflation are encouraged and cheered.

Commodity inflation comes next, which is deemed to be “just catching up to the improved economic conditions.

Transportation and food price inflation begin to take hold and the central bankers start to notice.

Wage inflation starts to take hold when the river nears the end of its pathway.

By the time we arrive at wage inflation the time to have started raising interest rates has already passed and the inflation cycle becomes self-reinforcing.

In a speech on February 8th, Fed board member Evans stated “the Fed has the tools to deal with higher inflation.”

I couldn’t agree more.

Raising interest rates in the present climate would halt inflation in its tracks. The question is: Does the Fed have the courage to raise interest rates?

We will see.

The two variables to keep an eye on in coming months are:

Nominal and real interest rates on longer term bonds.

The US dollar index.

Rising interest rates will challenge overvalued stocks and real estate markets. But a falling US dollar would intensify the desire of investors to buy assets at any cost.

Future comments will stay with these themes as they develop.

Please email me your questions and feedback, or if you'd like to review your portfolio.