Why Higher Interest Rates Won’t Fix This Inflation

Federal Reserve Chair Kevin Warsh used his Jackson Hole speech last week to say inflation is still too high. He also said current rates may not be restrictive enough. Markets now see a real chance of a September hike.

But higher rates can’t fix what’s actually driving inflation up.

Let’s look at the sources. Import tariffs are raising the cost of goods. Immigration enforcement is pulling workers out of farms and construction sites. Energy shocks are pushing up fertilizer and transportation costs.

This is a supply problem, not a demand problem.

None of this is about people spending too much money. It’s about the physical cost of producing things going up.

A rate hike works by making borrowing more expensive. Mortgages cost more. Business loans cost more. Credit card debt costs more. People and companies respond by spending less. That drop in spending is how the Fed cools inflation.

But that tool only works on inflation caused by too much demand chasing too little supply. It does nothing to build a house faster, staff a farm, or produce fertilizer.

Using rate hikes to fight supply-driven inflation doesn’t fix the cause. It just shrinks the economy until reduced demand matches the reduced supply. That’s a slower, more painful path to lower prices, and it raises the odds of an unnecessary recession. A rate hike is simply the wrong tool.

The real fix would be trade relief, expanded work visas for agriculture and construction, and investment in domestic energy and fertilizer capacity.

Rolling back tariffs on industrial inputs and raw materials would lower production costs right away. Expanding visa programs for farm labor and construction jobs would ease the worker shortage without touching broader immigration policy. Investing in domestic energy capacity, refining, and fertilizer production would insulate core goods prices from overseas shocks.

I don’t expect much of this to happen soon given where things stand politically. Rolling back tariffs and expanding immigration quotas both run into the current political environment, and neither side of that fight looks close to backing down.

It’s more likely that the administration holds its trade and immigration positions while making small, piecemeal fixes around the edges. The Fed keeps rates high to prevent these costs from becoming permanently baked into how people expect prices to behave.

The result is a slow grind rather than a sharp shock. Prices should moderate some as the initial tariff adjustment works through the system, but the underlying cost structure doesn’t go away. Growth slows, hiring cools, and the economy sits in that uncomfortable space between inflation and recession for longer than anyone would like.

That backdrop is a big reason we favor companies with strong free cash flow and real commodities exposure in our portfolios right now.

Free cash flow matters because a business that funds itself from its own operations doesn’t need cheap credit to keep growing. When borrowing costs stay high, that kind of company can keep investing and paying shareholders while more indebted competitors pull back.

Commodities exposure works from the other direction. When the price of oil, grain, or metals rises, a company that produces or holds those commodities usually sees its revenue rise with it, which offsets the same cost pressure that’s squeezing everyone else.

On the fixed income side, the same logic points toward short term bonds and floating rate debt instead of longer duration bonds. Short term bonds reset faster if rates move, so they carry less risk if the Fed starts to raise interest rates. When long-term rates go up, long-term bonds go down in value to adjust for the yield which has been locked in. Floating rate debt pays interest that adjusts with the Federal Funds rate and avoids this problem.

Together, these are three ways to hold up in an economy where input costs stay elevated and credit stays expensive, and neither one depends on guessing when the Fed moves next.

If you’d like to discuss your portfolio, feel free to reach out.

’till next time, keep calm and invest.

Nirav