Hello everybody, it's Sam from Financial Samurai. And in this episode, I want to talk about inflation and why people should not be freaking out about inflation. So the latest print was 7.5% CPI. So that's the highest inflation level in 40 years. Now personally, I don't think inflation is going to go much higher than 7.5%.

And I don't think mortgage rates are going to go much higher, for example, about 4% on the average 30-year fixed rate mortgage. Now, of course, I can be wrong. Nobody knows the future exactly. But this is what I believe. And there are three reasons why I think inflation is going to start fading by the end of 2022, and most certainly into 2023.

The first reason is rising long term bond yields. Look at the 10-year bond yield. It's gone from a low of 0.51% in 2020 to about 2% today in February 2022. Higher rates slow down borrowing. So that's deflationary. The second reason is a stronger dollar. The dollar, the US dollar has done very well in 2021.

Against a basket of currencies, the US dollar has appreciated by about 5%. As rates rise in the United States, more foreign capital will buy our treasury bonds and our assets because they are relatively more attractive. And as more capital buys US dollar-denominated assets, our currency tends to appreciate further in value.

So if we have an appreciating currency, that means foreign input costs become cheaper. So again, that is deflationary. And then finally, you're seeing inventories of products across the supply chain rise. Now, they're still quite tight, but they are rising. So if you look at supply and demand economics, if the supply curve shifts down, that means there is more supply at every single price point.

And that also is deflationary. America is one of the most capitalistic countries in the world. So in other words, when prices are rising, a lot of people, a lot of entrepreneurs, a lot of people who want to make a lot more money are thinking, how do we capitalize on rising prices?

And the simple way to do so is to produce more of that product. Eventually, enough people or enough companies will produce enough of that product where there will be an oversupply, and then there's going to be a price crash. So this is the classic boom, bust, bullwhip cycle that we all know about.

A great example is advertising. Just look at the Super Bowl commercials. A lot of them were investment ads, or cryptocurrency ads. And why is that? Well, it's because cryptocurrencies is the flavor of the year of the moment. So they're going to pay the most, and they are profiting the most.

And so of course, the networks are going to try to run these ads and also capitalize. So capitalism, capitalism is what is going to actually put inflation back down. Now, whether it's going to go back down to the long term historical average of between two to 3%, probably not, right, I think inflation is probably going to fade down to about 5%, or a little bit less by the end of 2022.

And then maybe fade down to three to 4% by 2023. But it's really hard to tell 12 months into the future. However, I certainly don't believe like one financial reader has bet me a lot of money, thinking that the average 30 year fixed mortgage rate is going to be above 6% by 2023.

This large bet, it's a $5,000 bet kind of came out of the blue. And it's also signifies how much fear and concern there is about inflation at the moment, in my opinion. I mean, usually bets are like $10, $20, $50, $100. Here's a reader who wants to bet me $5,000.

So I took the bet. And I took the under that the average 30 year fixed rate mortgage is going to be under 6% by the end of 2023. It's really important not to extrapolate elevated events many, many years into the future. For example, back in March 2020, if you're reading and listening Financial Samurai, you know, I was talking about how we should think about earnings, right?

To predict this bottom of the stock market, which I wrote a post about it on March, I think it's like 24th 2020, we have to look at earnings and where do we think earnings will bottom out and then restart recovering. And it was pretty analytical. And frankly, the post was spot on, right?

If we had been buying, which we were, we were buying in March, and in April, we've done very, very well. So to extrapolate, just doom and gloom for many, many years when everything was already cratering, was a mistake. And so right now with inflation at 40 year highs, to extrapolate inflation, staying at these levels seven and a half, 8%, 9%, 10%, for years and years to come, and thinking the Federal Reserve is going to hike, you know, 10 times 2%, 3%, 4%, and push mortgage rates all the way up back over 6%.

And then just really tighten and crush the economy. That is also unwise, in my opinion. If you look at rates, the bond market is doing the Fed's work for them, right? Because the 10 year bond yield and other bond yields have risen. And the Fed hasn't done anything yet, right?

The Fed is probably going to hike at least 25 base points, if not 50 basis points in March, and they're going to continue to hike probably by another 1% on the Fed funds rate. And that's the short end of the yield curve. So even if they go to one and a half percent, the 10 year bond yield is at 2%.

So the yield curve is still upward sloping, although it's really flat. And before the Fed gets to the end of 2023, it will probably change its mind a little, whether it's in terms of the pace of rate hikes, or the amount of rate hikes. So please be careful about extrapolating elevated events, or really one or two standard deviation events many years into the future.

Finally, since there are no certainties, there's no 100% certainty with any type of bet or investment, we have to be humble enough to realize we could get it wrong. I believe with 85% certainty, the average 30 year fixed rate mortgage is not going to be above 6%. And it's not even going to touch 6% by the end of 2023.

But that also means that I think there's a 15% chance I'll be wrong. So many things have happened, black swan events happen all the time. Therefore, we really need to have the humility that we could be wrong. And we probably will be wrong if we take risks, take action for a long enough period of time.

But the good thing is when we're wrong, we'll learn from our mistakes. And then we'll calibrate our investments better going forward. I'd love to hear your thoughts on where you think mortgage rates and inflation rates will be going in 2022 and 2023. Do you think I'm going to win the bet or a reader is going to win the bet?

And why? It's really important to think about these things if we're going to be putting our capital at risk. And if you enjoyed this podcast, I'd love a five star review and a positive comment. Thanks.