Three_reasons_why_Im_not_worried_about_inflation
00:00:00.000 | Hello everybody, it's Sam from Financial Samurai. And in this episode, I want to talk about inflation
00:00:04.400 | and why people should not be freaking out about inflation. So the latest print was 7.5%
00:00:11.840 | CPI. So that's the highest inflation level in 40 years. Now personally, I don't think inflation is
00:00:19.360 | going to go much higher than 7.5%. And I don't think mortgage rates are going to go much higher,
00:00:25.360 | for example, about 4% on the average 30-year fixed rate mortgage. Now, of course, I can be wrong.
00:00:32.160 | Nobody knows the future exactly. But this is what I believe. And there are three reasons why I think
00:00:38.800 | inflation is going to start fading by the end of 2022, and most certainly into 2023. The first
00:00:45.760 | reason is rising long term bond yields. Look at the 10-year bond yield. It's gone from a low of
00:00:52.000 | 0.51% in 2020 to about 2% today in February 2022. Higher rates slow down borrowing. So that's
00:01:02.080 | deflationary. The second reason is a stronger dollar. The dollar, the US dollar has done
00:01:08.240 | very well in 2021. Against a basket of currencies, the US dollar has appreciated by about 5%.
00:01:15.520 | As rates rise in the United States, more foreign capital will buy our treasury bonds and our
00:01:22.640 | assets because they are relatively more attractive. And as more capital buys US dollar-denominated
00:01:28.720 | assets, our currency tends to appreciate further in value. So if we have an appreciating currency,
00:01:36.720 | that means foreign input costs become cheaper. So again, that is deflationary. And then finally,
00:01:44.880 | you're seeing inventories of products across the supply chain rise. Now, they're still quite tight,
00:01:52.320 | but they are rising. So if you look at supply and demand economics, if the supply curve shifts down,
00:01:58.560 | that means there is more supply at every single price point. And that also is deflationary.
00:02:04.960 | America is one of the most capitalistic countries in the world. So in other words, when prices are
00:02:10.400 | rising, a lot of people, a lot of entrepreneurs, a lot of people who want to make a lot more money
00:02:15.920 | are thinking, how do we capitalize on rising prices? And the simple way to do so is to produce
00:02:22.640 | more of that product. Eventually, enough people or enough companies will produce enough of that
00:02:28.480 | product where there will be an oversupply, and then there's going to be a price crash. So this is
00:02:33.760 | the classic boom, bust, bullwhip cycle that we all know about. A great example is advertising.
00:02:41.440 | Just look at the Super Bowl commercials. A lot of them were investment ads, or cryptocurrency ads.
00:02:47.520 | And why is that? Well, it's because cryptocurrencies is the flavor of the year of the moment. So
00:02:54.080 | they're going to pay the most, and they are profiting the most. And so of course, the networks
00:02:58.960 | are going to try to run these ads and also capitalize. So capitalism, capitalism is what
00:03:04.720 | is going to actually put inflation back down. Now, whether it's going to go back down to the
00:03:10.480 | long term historical average of between two to 3%, probably not, right, I think inflation is
00:03:16.880 | probably going to fade down to about 5%, or a little bit less by the end of 2022. And then
00:03:22.720 | maybe fade down to three to 4% by 2023. But it's really hard to tell 12 months into the future.
00:03:29.360 | However, I certainly don't believe like one financial reader has bet me a lot of money,
00:03:35.440 | thinking that the average 30 year fixed mortgage rate is going to be above 6% by 2023. This large
00:03:42.560 | bet, it's a $5,000 bet kind of came out of the blue. And it's also signifies how much fear and
00:03:50.560 | concern there is about inflation at the moment, in my opinion. I mean, usually bets are like $10,
00:03:56.240 | $20, $50, $100. Here's a reader who wants to bet me $5,000. So I took the bet. And I took the under
00:04:03.200 | that the average 30 year fixed rate mortgage is going to be under 6% by the end of 2023.
00:04:08.960 | It's really important not to extrapolate elevated events many, many years into the future. For
00:04:15.280 | example, back in March 2020, if you're reading and listening Financial Samurai, you know, I was
00:04:20.560 | talking about how we should think about earnings, right? To predict this bottom of the stock market,
00:04:26.800 | which I wrote a post about it on March, I think it's like 24th 2020, we have to look at earnings
00:04:32.480 | and where do we think earnings will bottom out and then restart recovering. And it was pretty
00:04:37.440 | analytical. And frankly, the post was spot on, right? If we had been buying, which we were,
00:04:43.120 | we were buying in March, and in April, we've done very, very well. So to extrapolate, just
00:04:48.880 | doom and gloom for many, many years when everything was already cratering, was a mistake.
00:04:54.640 | And so right now with inflation at 40 year highs, to extrapolate inflation, staying at these levels
00:05:01.280 | seven and a half, 8%, 9%, 10%, for years and years to come, and thinking the Federal Reserve is going
00:05:06.640 | to hike, you know, 10 times 2%, 3%, 4%, and push mortgage rates all the way up back over 6%. And
00:05:14.640 | then just really tighten and crush the economy. That is also unwise, in my opinion. If you look
00:05:21.520 | at rates, the bond market is doing the Fed's work for them, right? Because the 10 year bond yield
00:05:28.000 | and other bond yields have risen. And the Fed hasn't done anything yet, right? The Fed is
00:05:32.560 | probably going to hike at least 25 base points, if not 50 basis points in March, and they're going
00:05:37.200 | to continue to hike probably by another 1% on the Fed funds rate. And that's the short end of the
00:05:43.040 | yield curve. So even if they go to one and a half percent, the 10 year bond yield is at 2%. So the
00:05:50.480 | yield curve is still upward sloping, although it's really flat. And before the Fed gets to the end of
00:05:56.800 | 2023, it will probably change its mind a little, whether it's in terms of the pace of rate hikes,
00:06:03.120 | or the amount of rate hikes. So please be careful about extrapolating elevated events, or really one
00:06:10.400 | or two standard deviation events many years into the future. Finally, since there are no certainties,
00:06:16.880 | there's no 100% certainty with any type of bet or investment, we have to be humble enough to
00:06:23.680 | realize we could get it wrong. I believe with 85% certainty, the average 30 year fixed rate mortgage
00:06:29.520 | is not going to be above 6%. And it's not even going to touch 6% by the end of 2023. But that
00:06:34.800 | also means that I think there's a 15% chance I'll be wrong. So many things have happened,
00:06:39.760 | black swan events happen all the time. Therefore, we really need to have the humility that we could
00:06:45.680 | be wrong. And we probably will be wrong if we take risks, take action for a long enough period of
00:06:52.080 | time. But the good thing is when we're wrong, we'll learn from our mistakes. And then we'll
00:06:56.400 | calibrate our investments better going forward. I'd love to hear your thoughts on where you think
00:07:02.080 | mortgage rates and inflation rates will be going in 2022 and 2023. Do you think I'm going to win
00:07:07.840 | the bet or a reader is going to win the bet? And why? It's really important to think about these
00:07:12.880 | things if we're going to be putting our capital at risk. And if you enjoyed this podcast, I'd
00:07:17.360 | love a five star review and a positive comment. Thanks.