Qwick Takes: Inflation may be high but remains manageable
This week, Talking Biz News Deputy Editor Erica Thompson reached out to Qwoted’s community of experts to inquire about the latest inflation trends and whether it is cause for concern yet.
Check out some of the top commentary:
Inflation reared its head in 2021, and despite the Fed considering it to be “transitory,” it’s clear it will be here for some time. Everyday families are experiencing price increases in many areas – consumer staples, groceries, gasoline, and appliances, to name a few. Supply shocks, labour shortages, COVID-19 and freight costs are all significant drivers. US Treasury Secretary Yellen says “we are not losing control of inflation” but she does acknowledge that it could take until the end of 2022 for price increases to subside.
The tricky thing about inflation is that, historically, when it starts, it creates a snowball effect that can take many years to correct – usually with higher rates, which are met with economic recession – neither of which we can afford given our significant global debt. For investors seeking to mitigate the impact of inflation on their portfolios, gold is a well-known inflation hedge, averaging 15% a year in periods where US CPI is 3% or higher; something we could certainly see. If Yellen is correct though, and prices do subside, it’s also good to know that gold has been a long-term performer and portfolio component, averaging 11% over the past 50 years.
Inflation is unpredictable and could go higher. Firms and their customers do not know where prices will go nor how to work inflation into long-term contracts. The Federal Reserve has lost its bearing of 2 percent, and it appears powerless to turn inflation around.
How long can the current trend continue before it presents a problem?
It already is a problem. Inflation is a tax on fixed-income earners and anyone holding US dollars—which means almost everyone in the United States. Inflation also generates what economists call shoe-leather and menu costs. People waste money trying to avoid inflation, and firms have to update their pricing to keep in line with inflation.
What Janet Yellen appears unwilling to acknowledge is that inflation expectations have now risen, and for the long haul. A return to near zero inflation would require a hawkish monetary policy that works strongly against expectations. That could catalyze a downturn.
There are other problems too, such as negative real interest rates and crowding out of private-sector investment, but the federal government appears utterly incapable of tightening its belt and reducing its dependence on deficit spending.
We are focusing heavily on ‘sticky’ price categories for signs of persistent rather than transitory inflation. Every inflation print this year has been muted within the sticky categories. However, for the first time, today’s report provided some conflicting signals on this front.
Healthcare inflation remained largely nonexistent — medical services prices fell 0.1% and are up less than 1% from a year ago. Education services inflation is also muted.
We do, however, notice a more notable pick-up in shelter — the largest CPI category. Rents rose 0.5% month-on-month while owners’ equivalent rent rose 0.4%. This is the fastest monthly rise in rents since 2016 and owners’ equivalent rent since 2006.
Importantly, these trends are less concerning on an annual basis, with rents and owners’ equivalent rents at 2.4% and 2.9% respectively, well below pre-COVID trends.
Also, crucially, one month does not make a trend. The figures have potentially been mildly distorted by ending mortgage forbearances, but we will stay laser-focused on these categories to see if a trend does emerge.
Continuing supply chain disruption will mean that inflation will potentially stay elevated for longer — in our view above 3% through Q2 2022. The large sticky categories will determine the ongoing run rate thereafter.
The jury is certainly still out on how the sticky categories will perform, and it remains the key metric to watch.
We anticipate that inflation will be manageable as markets eventually move towards a balance but there will be a period of adjustment in the interim from “cost push” inflation. Higher input costs that businesses are experiencing are already being passed along to consumers. However, consumers appear to be digesting these higher costs fairly well as consumer balance sheets remain strong. This dynamic is likely to change if consumers see prices continue to increase month after month at current rates as their willingness and ability to consume is reduced. However, we believe input costs will normalize before this dynamic occurs as supply constraints ease, production increases and demand shifts from goods to services.
Inflation these days is relative. The US has experienced very little inflation over the last ten years. The Federal Reserve (The Fed) has done everything in their power to get the inflation rate up to two percent and has been largely unsuccessful until recently. Many contend that the increase in inflation has very little to do with The Fed’s actions.
Most inflation comparisons are made based on the previous year. Remember where we were one year ago? In the midst of a worldwide pandemic where everyone had to stay home and the only things that went up in price were exercise equipment and home improvement supplies. As we are emerging from the pandemic, demand naturally increases. When you compare that increase to a year ago, of course, inflation has increased. Compared to the last ten years, it is fairly muted and manageable.
The one exception is labor costs. The pandemic has shifted the labor supply landscape and many mature workers have called it quits. This coupled with some lingering fear of returning to the work place due to COVID has reduced the supply of workers and will increase labor costs. Most other inflationary pressures are transitory but this one could be a problem.
Is inflation manageable? By our estimation, yes the current situation is manageable.
• Supply chain bottlenecks in shipping are currently an issue but we are already seeing signs of improvement in the number of ships waiting to unload and the cost to ship per container unit at our busiest ports.
• Oil recently hit multi-year highs, but unlike the 1970’s, the U.S. was actually a net exporter of oil in 2020, so we can increase our own supply. Total U.S. rig count has been steadily increasing since August of 2020.
• Semiconductor shortages remain an issue, but more manufacturing capacity is being built and supply should increase to help end users catch up in 2022.
• Higher wages may not be as transitory as other factors, but the impact on inflation could be somewhat reduced by changes in the workplace that focus on technology, such as working from home and improvements in automation.
• The supply and demand imbalances causing higher inflation may last longer than we initially expected, but there are reasons to agree with the Fed’s outlook that many of the factors causing higher inflation should be temporary.