Insights & Advice

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Are Inflation fears real or imagined?

If you have been grocery shopping lately, there is no question that prices and inflation are going higher. The same can be said for the price of a gallon of gas. But is it a transitory event, or are we at the beginning of an inflationary era not seen in decades?

Clearly, commodity prices, which are usually the harbinger of future inflation, are soaring. Copper, oil, sugar, corn, steel, aluminum and lumber, as well as many other food and material prices, are hitting multi-year highs. But it is not just commodities that are seeing a price surge. Shipping costs are also skyrocketing. And there are parts shortages that are leading to higher prices, plus a global semiconductor shortage that is sending microchip prices climbing.

Against this backdrop, the U.S. economy is exploding higher with the growth rate. This quarter and next combined are expected to exceed 10%. The nation is reopening and with it the demand (and prices) for everything from airline tickets to rental vacation cottages. The back-to-the-office crowd, as an example, has retailers trying to keep up with the sudden heightened demand for everything from dress trousers to make-up.

And while all this activity is gathering momentum, the U.S. government is feeding more fuel to the fire. Both government spending and monetary stimulus are at historical levels. We would need to go back to the Roosevelt Era to find a similar period of spending in our history. But this governmental expansion has even dwarfed FDR’s efforts.

Thanks to the pandemic, there have also been a growing number of supply shortages and logistical logjams worldwide. From diapers to toothpaste, consumer-related product scarcities are also contributing to rising prices. Time and again, during quarterly earnings calls over the last two weeks, corporate executives have complained about the mounting costs of almost every input to their businesses. Where they can, those costs will be passed on to the consumer through higher prices. The fear of inflation is no longer theoretical.

Up until now, if you listen to the Fed, the uptick in the rate of inflation is going according to plan. The need to expand GDP considerably will, by necessity, mean that inflation will move higher. They expect inflation to run “hot,” or at least hotter than would normally be the case.

Both the U.S. Treasury Secretary Janet Yellen, and Fed Chairman Jerome Powell, believe that a higher inflation rate will be necessary in order to get employment back to 2019 levels. Chairman Powell has said on many occasions that if inflation runs a little higher than their historical comfort level of around 2% that would be better than okay.

A higher rate of economic growth, they believe, will also address some of the potential scarring of the economy wrought by the pandemic. “Scarring” refers to the potential for permanent damage that may have occurred to the economy and the work force during the last year or so.

What has many investors concerned is that once the inflation genie is out of the bottle, it won’t be that easy to put it back in again. Will a 2.5% inflation rate, for example, be a transitory event, or the harbinger of something more?  And if so, how much more?

Will the Fed be forced to hike interest rates, if inflation runs amuck? Will they take away the monetary punch bowel and with it the stock market and the economy?

One thing is clear. Until we know the truth, investors will be sleeping with one eye open. In recent days, several Fed members, in speeches around the country, have mentioned the “potential” for tapering in the near future–something opposite of the Fed’s stated policy position. In addition, this week, Secretary Yellen also mentioned a possible need for higher rates ahead. That riled the markets, and she later walked back that statement. Investors dismissed it as a “slip.”  It is hard to believe that a veteran like Yellen would say anything in any circumstance.

My own thinking is that what we are hearing are a series of ‘trial balloons.’ It is usually the method by which the Fed and other official entities gauge and test the reaction to future policy changes. Could it be that, despite the central bank’s belief that their lower-for-longer stance is the right approach, there may be the need to adjust if prices continue to ratchet too much higher? Afterall, when you allow things to heat up there is always the chance of being burned.

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