Relationship Between Inflation and Interest through History

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Inflation and interest rates tend to move at the same direction. The reason is that interest rates is the Fed’s sliding monetary policy in order to reach a 2% annual inflation target.

However, due to Covid, inflation has ran rampant and has a hit 8.5% in April 22′. In order to curb inflation, the Federal Reserve has released a statement to set a new interest rate target of 1%, whereas interest rates was near 0% for the last decade.

Annual Inflation vs Interest Rates

During the “Great Inflation” periods of the 1970s, we have seen interest rates rise to over 15% in the 1980s. From this point onwards, interest rates have been on a decelerating trend to almost near 0% after the subprime mortgage bust of 08′.

This period of free cash saw one of the longest bull market in history and an explosion in returns from high growth sectors such as tech.

Inflation did see a rise starting 2017, which the fed responded with a slight increase in interest rates. The trend looked to continue until Covid in 2020 which the Feds immediately decreased interest rates back to 0% to avoid a recession.

S&P 500 average close prices throughout history + forecasts through our OKR model

Looking Into the Future

Now that Covid is a thing of the past, the question now is how aggressive the Feds are looking to increase interest rates to fight inflation. Historically, the Feds have increased inflation to 1X to 1.5X inflation rate. By that standard, interest rates will rise to ~8%. This increase will send shockwaves across sectors, particular growth sectors that highly rely on debt financing and leverage to sustain their growth.

Putting it all together, when inflation runs rampant and is well beyond the 2% target, interest rates will rise to combat inflation, and the market will trade sideways until inflation is back within the Fed’s target.

When inflation is back within target, the market will most likely see a bull run until the next “bubble” or “black swan” event. The million dollar question here is how much the Feds need to increase interest rates in order to set inflation back within it’s limits + how long will this high interest rate period last.

Although interest rate is unlikely to jump into the double digits we’ve seen during the great inflationary periods of the 1970s, an interest rate increase to over 5% is likely. We’ve seen in during the 90s, as well as periods leading up to 08′.

As a real estate investor as well, it’ll be extremely interesting for me to see the relationship of interest rates and real estate prices through history. As always, stay tuned for more interesting analysis with OKR.


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