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During the 1970s, the U.S. experienced three major waves of inflation, with rates soaring as high as 15%. Each surge led to a significant stock market downturn, with U.S. stocks declining by more than 20% each time. Fast forward to today, inflation has once again become a pressing issue. The recent inflation spike—the largest since the 1970s—triggered a 25% drop in stocks in 2022. Now, with the Trump administration’s proposed policies, some economists warn that this could be just the first wave of a new inflationary cycle, potentially mirroring the economic turmoil of the 1970s.

The International Monetary Fund (IMF) has raised concerns, cautioning that Trump’s policies—such as higher tariffs and stricter immigration laws—could fuel inflation. Increased tariffs would drive up the cost of imported goods, with businesses likely passing those costs onto consumers. Meanwhile, stricter immigration policies could lead to labor shortages, forcing companies to raise wages to attract workers—ultimately driving up business costs, wages, and inflation.

However, some argue that the IMF may be focusing too much on Trump’s policies and not enough on the Federal Reserve’s role. The Fed plays a crucial part in managing inflation, and its current approach differs significantly from past inflationary periods. Take the early 1970s, for example: when inflation started rising, the Fed aggressively increased interest rates from around 2% to over 12% between 1972 and 1974. But once inflation showed signs of slowing, the Fed quickly cut rates. Throughout 1975 and 1976, interest rates remained below the inflation rate, a decision many experts believe ultimately led to another surge, pushing inflation as high as 18%.

A similar pattern emerged in 2022, when the Fed funds rate was below inflation, preceding another major spike. This situation—where interest rates are lower than inflation—is known as negative real interest rates, which encourage economic activity through cheap borrowing but also contribute to inflation. IMF research has shown that negative real interest rate policies have been effective in stimulating economies with low inflation, as seen in Denmark, Japan, and Sweden.

Today, however, the Federal Reserve has taken a different approach. The current interest rate stands at 4.5%, while inflation sits at 2.9%, meaning interest rates are now higher than inflation. This marks a departure from past strategies and could have significant implications for the trajectory of inflation going forward.

This is known as positive real interest rates, the opposite of the policies implemented in the early 1970s and again in 2022. Positive real interest rates encourage saving over borrowing, which helps cool the economy and typically brings inflation down.

We've seen this approach work before. During the high inflation of the 1970s, Fed Chairman Paul Volcker adopted a strict policy of maintaining positive real interest rates, ensuring that the Federal Reserve's interest rate remained higher than the rate of inflation. A look at historical data shows that he consistently kept interest rates above inflation throughout his tenure, which ultimately helped bring inflation down.

This was a stark contrast to the monetary policy of the early 1970s, where low interest rates contributed to rising inflation. Today's monetary policy resembles Volcker’s approach more than the inflationary policies of the early 1970s. Even if the IMF’s concerns about Trump’s policies leading to inflation are valid, the Fed appears well-positioned to counteract these risks through its commitment to positive real interest rates.

One key sign of the Fed’s continued effort to keep inflation in check is seen in the housing market. Housing plays a crucial role in inflation, making up nearly 45% of the Consumer Price Index (CPI)—the largest single component of inflation data. This is logical, as housing is one of the biggest expenses for most households. When home prices and rents increase, they significantly impact overall consumer spending.

Following the pandemic in 2020, home prices surged, contributing substantially to rising inflation. However, with higher interest rates in place today, the housing market has started to cool, reflecting the broader effects of the Fed’s efforts to manage inflation.

Since the second quarter of 2022, when real interest rates turned positive, the housing market has cooled significantly. In fact, median home prices have been declining over the past year, signaling downward pressure on inflation.

It's not just home prices that have been easing—rent prices have also been falling. Data from the Cleveland Fed, which tracks rent prices for new tenants, shows that landlords are charging significantly less for newly signed rental agreements. This metric is now at levels last seen during the financial crisis.

Interestingly, when we overlay this new tenant rent data with official rent inflation figures, we see a clear pattern: new tenant rent trends tend to predict CPI rent inflation by about nine months. Given the current contraction in new tenant rents, further declines in rent inflation are likely, reinforcing broader disinflationary trends similar to those seen in home prices.

So while Trump's policies will undoubtedly shape the economy, investors should not overlook the Federal Reserve’s influence on inflation. The Fed's current stance on interest rates continues to exert downward pressure on inflation, counteracting other potential inflationary forces.

Disclaimer: I want to make it clear that I am not a financial advisor, and nothing I say is intended to be a recommendation to buy or sell any financial instrument. Additionally, it's important to remember that there are no guarantees or certainties in trading or investing, and you should never invest money that you can't afford to lose.

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