From March 2022 to July 2023, the Federal Reserve raised interest rates 11 times in an effort to curb inflation.
Perhaps the most pernicious feature of inflation is that it spreads -- impacting everything from consumer purchasing power to labor costs, food production, and more.
Fed Chairman Jerome Powell has expressed on numerous occasions that his long-term inflation target is 2%. While inflation has cooled from peak levels, the current rate of 3.2% suggests the battle is far from over.
With inflation being top of mind for most economists, one notable investor is worried about something else entirely. Earlier this month, Ark Invest CEO and famed technology investor Cathie Wood expressed her concerns over the economy in a shareholder letter.
Let's dive into Wood's argument and assess her outlook on the economy.
What is Cathie Wood worried about?
In her letter, Wood explains that commodity prices have fallen to deflationary levels following the Fed's rate hikes. This concerning trend has Wood declaring that "the Fed's fears about inflation are misplaced."
In her view, deflation should be the primary concern.
Image source: Getty Images.
How deflation could spell trouble
Inflation is a term used to describe the rate at which prices of goods and services rise. By contrast, deflation is used to describe when prices are falling.
On the surface, you might think that a general fall in prices is a good thing. After all, you'll be able to buy more stuff. However, deflation is actually a negative thing from an economic standpoint.
Let's say a company decided to drop prices after noticing a deceleration in sales. While this might appear like an opportunity to capitalize on lower prices, there's something more concerning at play here.
Essentially, such a move would suggest that spending habits are on the decline. So, in an effort to entice people to go out and spend their money, businesses are forced to lower prices. That's not a good thing. Moreover, if this were to happen, consumers might actually continue to delay spending in hopes that prices fall even further -- which would be worse.
Pay attention to the Federal Reserve
Wood suggests that ChatGPT and other breakthroughs in artificial intelligence (AI) could lead to "creative destruction." Over the last year, business leaders and even politicians have expressed a similar sentiment -- concerns that AI could put people out of work.
I understand this argument, and it's entirely plausible that advancements in robotics and other areas in AI could result in layoffs at some point in the future. In turn, there could be a meaningful downward swing in the prices of goods and services. However, I think the narrative suggesting that efficiencies gained through AI could lead to widespread deflation is rooted more in theory than concrete evidence.
Wood goes on to say that regional bank failures and strains in the commercial real estate market are products of the Fed's policies, and proof that deflation is already manifesting. Candidly, I find these comparisons uncompelling.
Commercial real estate has been under pressure since the inception of the COVID-19 pandemic. Landlords owning office space and even apartment complexes have felt some pain given the paradigm shift in corporate culture from primarily in-office to remote work and hybrid environments. From my purview, I don't really see how deflation is relevant in this situation.
Could deflation be a problem hiding in plain sight? Maybe. However, I think investors are better off paying close attention to comments from the Fed. While Chairman Powell and his constituents may not be in the spotlight as often as Wood, leadership from the Fed provides enough public commentary to at least give a glimpse as to what their concerns are. As far as I can tell, the Fed is laser focused on inflation -- not deflation.
While I respect Wood as an investor, it's important to understand that she is known to make contrarian and sometimes even far-fetched commentary. If anything, I found her shareholder letter intriguing. As an investor, I'll continue to monitor inflation data and listen to commentary out of the Fed as well as leadership from the companies that I am invested in.
