The Federal Reserve just boosted interest rates and may do so again. The most relevant question for ordinary investors is not how high rates will go but where they will settle once the Fed is done with this cycle of curtailing inflation.

Fed Chairman Jerome Powell insists he is committed to bringing inflation down to 2%. He may have to settle for something higher as he confronts both deflationary and inflationary forces.

COVID-era supply-chain problems have mostly resolved. In China, the economic recovery is halting, factories are operating at less than full capacity and the yuan is down against the U.S. dollar. All of which should make importing from China cheaper for U.S. consumers. However, record heat, drought and new disruptions to Ukrainian grain exports threaten renewed food commodity inflation.

Many sectors that higher interest rates should have slowed are proving stubborn. Automakers have rebounded from pandemic-era semiconductor shortages and are making cars and light trucks at a pre-COVID pace. The U.S. government’s Infrastructure, Chips and Science and Inflation Reduction acts are instigating double-digit annual gains in medical, road and public works construction. Factory building was up 76% in May. No surprise, concrete and cement are in short supply and prices have jumped.

Labor shortages and layoffs

Labor and equipment shortages continue to plague service industries. Auto repair shops can’t find enough technicians. The sale of electric vehicles alongside gasoline cars challenges suppliers to adequately stock a broadening range of replacement parts — shortages abound.

Meanwhile, tourism is booming. Airplanes are crammed and airlines can’t get new planes delivered fast enough or find enough qualified pilots.

Yet in other places industries are slowing— witness the layoffs in big tech and finance and slowing sales of clothing and footwear. If the U.S. economy slips into a recession, it will be mild, or it may last only a few quarters with GDP advancing but at less than 1%.

Overall, labor markets may not be as red-hot as they were earlier this year but those are tight enough. According to the Atlanta Fed, wages continue to rise at about 5.6% a year.

Consumer expectations about inflation are hardening. The Conference Board, New York Federal Reserve Bank and University of Michigan latest surveys of one-year inflation expectations all average about 4.3%. In this environment, mortgages above 6% are not terribly high if homebuyers expect inflation to persist and expect their incomes to keep rising too.

That’s an important reason why home prices are rising again. During the decade between the Global Financial Crisis and COVID shutdowns, the Consumer Price Index rose an average of 1.8% a year, and the overnight bank-lending rate the Fed targets averaged 0.62% and never exceeded 2.5%.

This was the golden era of globalization when multinational enterprises concentrated sourcing on least cost suppliers without regard to geopolitical, pandemic or other systemic risks.

Now decoupling and hardening of supply chains to cope with continuing tensions with Russia, the potential for rupture in U.S.-China relations, the expensive shift to carbon free energy sources and mitigating climate change damages are pushing up costs.

All this portends inflation closer to 4% than 2%. If the economy manages to grow 2%, that translates into overnight lending rate closer to 6% than the rock-bottom levels of the 2010s.

Buying and investing now

If you want to buy a home, there is no time like the present. Mortgage rates may dip but will generally stay significantly elevated. Prices could fall in cities that many people want to flee, like San Francisco, but in most places, both new and existing home prices will continue rising.

Interest on U.S. bonds should be decent but U.S. stocks historically have and will likely continue to outperform bonds by a wide margin. Large-cap stocks like those in the S&P 500 SPX are particularly favorable because big firms tend to have more pricing power and can more easily pass along higher costs for labor and material than smaller businesses can.

If you go with the traditional conservative portolio prescription of 40% bonds and 60% stocks, put aside some cash in a money-market account. If you are in a high-tax bracket, consider a mutual fund or exchange-traded fund that invests in near-dated state- and local debt that virtually guarantees the value of your principal will not be affected by abrupt movements in interest rates — for example, the Vanguard Municipal Money Market Fund.

Put the rest of your fixed-income allocations into staggered-maturity U.S. Treasury securities — depending on the yield at the time and how long you can tie up your money. Those can be purchased at TreasuryDirect.com.

For the 60% in equities, consider a low-fee S&P 500 index fund from a large provider such as USAA, Fidelity Investments or Vanguard. If you can afford to tie up more of your money and are far from retirement age or don’t need the cash right now, for example for college expenses, weigh more to stocks, perhaps 80%.
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Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.