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The investment outlook is clouded by surging inflation. Will inflation revert to its tame rate, as the Federal Reserve expects?

By early 2022, the Federal Reserve Bank’s forecast of inflation will be coming true or not. 

Until then, U.S. stock prices could be highly volatile as speculators and investors with near-term cash needs cash in or out of the stock market.    

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Despite the Covid economic recession, disposable personal income and personal spending are at or higher than the level they would be had the pandemic never happened.

Three rounds of government direct payments from the federal government, along with extra unemployment benefit checks, have financed a cash hoard.

That’s why the savings rate is at 12% coming out of the Covid recession. That stockpile of savings is getting spent now, which is triggering shortages and hikes in prices in some products and inflation fears.

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The red line shows the  surge in inflation from a 1.1% annual rate in November 2020 to 3.9% in May 2021 is the main fear factor driving prices for stocks, bonds, and other capital-gain investments.  

While the financial press usually focuses on the Consumer Price Index measure of inflation, the Personal Consumption Expenditure Deflator (PCED) index is the index Federal Reserve references in policy pronouncements. It’s what matters to investors.

The gray dotted lines show the range of inflation forecasts made late last month by the 18 members of the Federal Reserve Bank’s Federal Open Market Committee, which sets lending rates in the United States. The dotted gray lines, representing the highest and lowest inflation forecasts made by the 18 central bankers, show the Fed expects inflation to plunge in January 2022, from a 3.5% annualized rate, to 2.3%. The Fed’s inflation forecast is controversial because the Fed’s record of forecasting inflation is not so great. 

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The Fed has predicted a 12-month inflation rate, as measure by the PCED, of 2% for a decade, but the PCED inflation benchmark has been hugging a 1.5% annual rate. To be clear, the Fed has been wrong on inflation for a decade, and, now that inflation is surging for the first time in years and is at a pivotal point, an incorrect Fed forecast could trigger heightened inflation fears. 

Fed’s policy mistakes have caused almost every recession since World War II.     

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The Standard & Poor’s 500 stock index closed at an all time high of 4,280.70 today. The index gained +0.33% from Thursday and +2.75% from last week. The S&P 500 index is up +62.69% from the March 23, 2020 bear market low.