August 2, 2021
The answer is likely that some of the inflation we are experiencing will stay for a sustained period, but it is quite possible that much of the recent spike will dissipate as supply chains reopen and comparisons to the very low levels during the pandemic roll off.
Some of the headlines have been shocking, like “U.S. inflation soars to 13-year high.” True, CPI jumped 0.9% in June, the largest 1-month change since June 2008 when the index rose 1.0 percent(1). Also, using the more common year-over -year comparison, CPI has increased 5.4 percent and is the highest since it reached a similar level in August 2008.
Much of the recent jump has been fueled by the sharp rise in prices for used cars and trucks that increased 10.5 percent in June. Wow! Energy prices are also up significantly over the past year. We do expect much of this inflation to persist over the next couple of quarters, but to be more transitory as supply chains heal and low comparisons roll off. On the other hand, increases in wage growth are likely to persist. Wage growth is up to 4.6%, above the 50-year average of 4%. Unemployment stands at 5.9% in June with notable job gains in leisure and hospitality. However, while we expect the unemployment rate to fall, future declines may be tempered by an increase in labor force participation as childcare options reopen and government supplemental unemployment benefits expire.
To us, the key determinant of transitory versus persistent inflation is the amount of inflation that seeps into wages. For its part, the Federal Reserve recently raised its inflation expectation for 2021 to 3%, up from 2.2% in March. This appears low based on the current numbers. Right or wrong, the Fed appears to be okay with the inflation rate and is not in a hurry to intervene. Chairman Powell has said numerous times that the Fed had made mistakes in the past trying to step in and control inflation and is willing to let prices rise above the central bank’s 2% target for a modest period. The Fed has also indicated that 2021 inflation should give way to more stable price growth over the longer term. Our base case is the tapering of bond buying by the end of this year and rate increases by the end of 2022.
In the final analysis we suggest avoiding “knee jerk” reactions to sensational inflation headlines and maintaining allocations to equities that tend to pass on the effects of inflation over time.