Based on recent survey results, Bank of America concluded that inflation is the biggest risk to the markets right now. The data was according to the closely watched Global Fund Manager Survey, where a record 69% of respondents see above-trend growth and inflation as the most likely scenario ahead.
But how much inflation can the United States afford before we’re in trouble?
First, let’s get on the same page about the basics. If you’ve noticed the price of an item increase over time — say, your favorite candy bar or the cost of college tuition — that’s inflation in action. Economists use the broad increase, or decrease, in prices of goods and services across the country as a measure of economic health. When inflation is stable and predictable, it’s a sign of a healthy, growing economy.
But, high inflation can quickly eat away at the purchasing power of your dollars, indicating that the economy might be overheated. It particularly can have a negative impact on retirees.
Deflation, or a decline in prices, can be a warning sign of a shrinking economy.
Recent data highlighted a surprise spike in inflation, indicating that prices increased faster than economists expected last month. Could this be a worrisome sign that the economy is overheated? Could $50 burgers be in our future? Maybe.
On the other hand, could it be a temporary blip caused by the economy emerging from the COVID-19 pandemic-driven slowdown, complicated by supply chain issues? Fed Chairman Jerome Powell used the word transitory nine times in his April press conference. Boston Fed President Eric Rosengren claims that the current inflation will be temporary similar to the toilet paper shortage of 2020. So, yes — it’s very possible. Are the headlines catastrophizing? They usually are.
The Consumer Price Index (CPI), one of the major indexes economists use to track inflation, showed a surprising spike in April, igniting fears of runaway inflation. Core CPI (which excludes the highly volatile categories of energy and food) showed a 0.9% increase in April month-over-month and 3.0% year-over-year. That’s much higher than the expected 0.3% and 2.3%, respectively.
However, digging a bit deeper, we see that just two categories of goods (used cars and transportation services) accounted for the vast majority of the surge.
That suggests things like flights and train travel suddenly became more expensive after a year of rock-bottom prices. Is that runaway inflation or the normalization of prices as the world reopens?
We can’t tell from a single data point, but it’s not unusual to see prices increase in sectors that experienced a severe slowdown last year.
And the jump in used car prices? Well, many folks are turning to the second-hand market right now, in part because new cars are caught up in global supply chain bottlenecks for things like semiconductors and raw materials.
Inflation is something to keep an eye on, especially in a year when so many of the usual variables have been thrown into flux. An ongoing surge in prices could hurt our wallets as our dollars buy less over time. However, a single monthly spike following a very weird period for the economy is not cause for alarm yet; we should prepare ourselves for more odd numbers coming out of different parts of the economy in the weeks and months to come.
Shortages of everything from ketchup to gasoline could lead to price increases and fluctuations as supply chains attempt to disentangle from pandemic disruptions.
Over the last 30 years, inflation hawks have sounded the alarm when concerns proved to be temporary.
What Could Be Different This Time
- The Fed’s super-easy monetary policy. The Fed insists it will not raise rates until the economy reaches full employment. It’s not yet ready to talk about tapering. Investors fear that the Fed will fall behind the curve.
- Massive government stimulus is being pumped into the economy, such as the latest $2 trillion relief package that included $1,400 stimulus checks for qualifying taxpayers. Too much money set to chase too few goods amid strong demand and capacity constraints.
- Huge increases in government spending have been proposed.
- A severe labor shortage may drive up wages, which could get tacked onto prices.
- The prices of commodities are rising.
Why the Spike in Inflation Could Be Temporary
- Supply constraints will eventually ease, relieving bottlenecks and pricing.
- Few people anticipate another round of stimulus checks.
- For most businesses, labor is the biggest cost.
- The Employment Cost Index, which is a comprehensive measure of compensation, has risen but remains generally muted.
- The Fed is more attuned today than in the 1970s and would more likely hit the monetary brakes in order to meet its longer-term inflation goal, if outsized price hikes continue.
Should We Expect Markets to React to Inflation (and Other) Headlines?
A negative market reaction is not surprising after weeks of strong performance. We should expect volatility ahead as we — and the economy — adjust to a post-pandemic world.