Weekly Watch | Inflation: Prices on the Rise

Inflation is always and everywhere a monetary phenomenon. - Milton Friedman 

For those who follow macroeconomic trends, inflation and Federal Reserve policies, the first half of 2021 has been quite mind-boggling. It also comes as no surprise that the Federal Reserve opted to keep interest rates unchanged in the latest Federal Open Market Committee (FOMC) meeting this past Wednesday. However, the committee did hint towards the possibility of multiple rate hikes by the end of 2023, which is sooner than they had indicated back in March. The hysteria and frenzy surrounding inflation among the financial media has remained unabated, as many investors are seeking new havens to place their cash. Additionally, as corporate America struggles to find cheap labor in conjunction with sustained unemployment, investors have begun to realize that workers appear to have unfamiliar bargaining power over traditional stagnant wages. With the tightening labor market, a growing demand for workers, and people retiring at higher rates, the path back to a strong recovery may ultimately require increased participation and rising wages. As a result, hysterical headlines concerning inflation have begun to flood the mass media, whether it be imaginary or real. What is real, however, is that dollars spent today on food, energy, housing, education, and health care all continue to buy less. At the end of the day, these factors are simply not optional for survival or advancement, though the hasty growth of retail, automotive, airfare and housing from their previous low levels has allowed investors and consumers alike to have a distorted view of our current economic condition.  

On June 10th, 2021, the Bureau of Labor Statistics (BLS) reported that the Consumer Price Index (CPI-U) increased 5 percent; making it the largest 12-month increase since the Great Recession in the August period of 2008. The Consumer Price Index is the primary method used to track and calculate the average change in prices for specific “baskets” of goods and services for all urban consumers. Essentially, the consumer price index is the fundamental measure used to calculate inflation rates and accounts for only the consumption of households. It is equally important to note that there is an abundance of unique dynamics at play, especially when reopening an economy that is powered by a slew of consumer spending.  

Undoubtedly, an economic boom is coming as vaccines are now allowing people to return to normal day-to-day life. Even with many unprecedented monetary and fiscal policies, which are designed to dampen aggregate demand, the Fed remains confident that inflation will remain close to its 2 percent longer-run target. To some, it appears as if the central bank’s outlook rests on the experience of the 2007-2009 recession, a period in which inflation stood shallow despite fiscal stimulus. But today’s economic conditions are vastly different from the following decade, raising the chances that the Fed may be caught flat-footed by higher-than-expected inflation due to the printing of trillions of dollars. Even so, the Fed has signaled that it will keep interest rates at near-zero and continue to buy treasuries and mortgage-backed securities within an already red-hot economy. Luckily, financial markets love this, basking in low yields and high profits. On the other hand, if the Fed is too unhurried to combat its emergency monetary responses because of the pandemic, they run the risk of unfavorably jarring financial markets and the overall economy. For now, the central bank still looks like it has its head in the sand.  

All-in-all, the Fed’s angst over falling inflationary expectations seems dislocated, and their original optimistic assessment of inflation seems more unbalanced than untimely. More realistic measures will soon have to be taken, and the Fed should prepare pecuniary markets for an unwinding of its asset purchases with the eventual rise in interest rates. Rising rates, in combination with strong economic growth, could possibly be a favorable adjustment to extend the expansion and encourage sustainable job creation for years to come. Although we are living in an extraordinary time, it seems more than likely that we will not return to our perceived sense of “normal” anytime soon. Instead of betting on pure inflation trades, we believe it is more beneficial to probe for investments that can flourish in both inflationary and deflationary environments.