Inflation May Last Past This Summer – Experts Warn

by admin | July 25, 2022 | Real Estate

 

Inflation and its effects on the quality of life are a growing concern for most Americans. The mounting cost of living affects everyone as they have to deal with rising fuel and food prices yet contend with stagnant pay packets. But there’s a silver lining coming up soon, right?

Not according to Goldman Sachs economists. They think the dark days are far from over. So why are they so bullish about the gloomy days ahead? That’s what we’re here to find out, so buckle up for a bumpy ride.

Inflation and Its Causes

 

Food prices rose 9.4% from April 2021, the highest rise in over 40 years. The Food and Agriculture Organization (FAO) reported an increase in the monthly food price index, up 12.6% from February to March 2022, the most significant rise since 1990.

Most experts blame Russia’s invasion of Ukraine and pent-up consumer demand post-pandemic. Moreover, there was a surge in global prices of coarse grains and wheat, mainly due to disruptions from Ukraine, the world’s largest wheat exporter, and Russia, one of the world’s largest suppliers of oil and wheat.

The World Economic Forum states that 16% of Americans are struggling financially. On the 11th of May, Economist Mohamed El-Erian told CNBC that it was only a matter of time before Americans grappled with a “cost of living crisis.”

The all-items index rose 9.1% in 12 months before seasonal adjustment. To counter this, the Federal Reserve decided to fight fire with fire by making a 0.75%-1% interest rate hike, the highest it has ever made in 22 years.

How did we get here?

 

When Covid-19 struck, many countries around the world went into lockdowns. That set off a chain reaction of events, including factories shutting down, businesses shuttering up, and work from home becoming a thing. Most governments stepped in, providing support to keep the economy alive and people out of poverty.

Because of the non-existent opportunities to spend that, many people built up unexpected savings. When governments lifted the restrictions, people instantly poured these savings back into the economy—cue pandemonium.

The challenge is that many countries worldwide, especially the world’s factory China, still face intermittent lockdowns. So, despite the money people pumped into the economy, businesses can’t keep up with the demand, so prices continue to soar.

Another major culprit is the housing market. The median home sale prices climbed steadily throughout 2022, hitting an all-time record of $407,600 in May 2022 due to feverish demand despite higher mortgage costs.  

That presents a problem on several fronts:

  • The high prices are eating into people’s disposable income
  • First-time buyers can’t afford homes, so they can only lease
  • That will keep driving rent prices up as embattled landlords try to keep up with demand and jacked up mortgage rates.

Inflation isn’t always a bad thing. However, when the prices of items keep increasing for too long, it becomes a cause for concern. That probably explains the Federal Reserve’s “wait-and-see” strategy before it finally clamped down on inflation.

 

What to Expect – Inflation to Last Through the Summer

 

Experts suggest that inflation will remain as long as the Russia-Ukraine conflict continues to aggravate the effects of the Covid-19 pandemic. Various indicators like soaring transport costs, shortage of key inputs for production, a shock to energy markets, and extremely long suppliers’ delivery times seem to persist despite governments’ and private enterprises’ best efforts.

Eventually, these supply issues will ease as the supply chain adapts, demand weakens, or the Russia-Ukraine conflict ends. If wages rose in line with inflation, there wouldn’t be cause for concern because purchasing power would remain the same.

Then there’s the housing market. As Larry Summers, the 71st Secretary of Treasury points out, the consumer price index (CPI) isn’t an accurate gauge of the economic environment. He warns that inflation will get a lot worse in 2022. Here’s why.

Summers warns that the current environment mirrors the events of 1983, where the CPI didn’t factor in the effects of the housing market, as they didn’t factor in aspects of housing between 1953 and 1983.

The kicker? While inflation has hit 9.1%, Summers thinks inflation might be a lot worse than the official figures suggest. He and plenty of others believe the only way to combat the current inflation is to raise interest rates even further and inflation with it, a move which seems on the horizon judging by the current mood at the Federal Reserve.

Although the Federal Reserve’s current interventions mean mortgage rates skyrocketed past 6%, the highest since 2008, it has done little to cool down the housing market. And it’s easy to see why. The magnitude and hiked consumer price index and the delay in transmitting its impact mean it will take time for the market to feel the spillover between home sales and rents.

If anything, a Bloomberg model expects the CPI for people renting their primary residence to accelerate from the current 4.4% (March figures) to 7.4% in September 2022. That will only decelerate if rents slow down substantially.

 

Will Real Estate Beat Inflation Over Time?

 

While employment is still strong, and the price of commodities such as meat, eggs, poultry, and fish slumped 1.8% in June 2022, inflation-adjusted income is down 3.6% from last year, and commodities prices are up 11.7% annually. Further, medical care costs rose on the month, gas jumped almost 60% over 12 months, and electricity rose 1.6% on the year.

The data isn’t encouraging, so word on the street is that the Fed wants to jack up interest rates closer to the 2% range. So, can real estate survive depressed wages, sky-high mortgage rates, and spiraling inflation?

That will depend on how fast rents slow. However, expecting rents to slow is a long shot, considering rent yield naturally grows with time. That’s not even considering the interest rate hikes that inevitably raise mortgage prices, which predictably leads to rent increases.

Although mortgage rate hikes lead to increased rents and inflation, you can bet on real estate as inflation helps if you use cash-flowing real estate to offset a long-term interest rate debt. Here’s how:

    • Enhanced cash flow: if you have a fixed mortgage rate, the interest and principal payments remain fixed over time, so yearly rent increases go straight to your pocket, minus the minuscule rise in inflation-assisted operating costs.
    • Asset price inflation: The equity in your home will grow faster during inflation as the valuation of housing rises.  

 

 

Final Word – What Americans Should Expect

 

Americans may need to strap in as the crisis hits record highs and shows no sign of letting up this summer. Tighter household budgets and lower purchasing power will be the norm for the next few months, but you can leverage real estate to beat inflation, however daunting it seems.

Tags: