Ever since the ten-year treasury’s rapid accent in February, inflation has become the primary concern for both the equity and bond market. However, since the slightly (& brief) hawkish tone out of the Federal Reserve in their May meeting, followed by a disappointing jobs report, the ten-year started to fall drastically and now sits around 1.25%. At the same time, we have seen very high inflation readings over the last few months. The true question is whether the unprecedented amounts of fiscal and monetary stimulus, with the potential for more to come, is going to lead to persistent levels of inflation in the future?
Fed chair Jerome Powell has been sticking to his guns, slipping in the word “transitory” whenever he can. It was only recently that the Fed admitted that they are above their inflation goals, but will need it to be broad and persistent, while seeing an improvement in the labor market. I was starting to believe that the Fed would continue disregard any higher-than-expected inflation data, but after listening to Powell answer question after question about inflation in front of Congress, it is clear he doesn’t see inflation as being broad across the economy. This coincides with the latest reading of CPI where close to 70% of the gain was attributed to a few select areas including car sales, travel, and hotel. We have also seen commodity prices roll over with the biggest decline occurring in lumber prices. The more persistent area of inflation is wages, as companies have and will have to increase compensation to attract workers. Higher wages along with higher inflation expectations will likely leave us at inflationary levels that are above what we have seen throughout the last economic recovery.
But are we at risk to enter a hyperinflationary environment? It is my belief that we will remain at lower tier inflationary levels compared to historical trends. There are many deflationary drivers that are interwoven in our current economy. Baby boomers continue to leave the workforce leading to lower spending, advancements in technology have led to increased productivity, and globalization has led to a more competitive pricing environment. In the past the United States’ higher inflationary regimes tended to coincide with the time preparing and fighting a war. The most notable inflationary period was in the decades of the 70s when there were large amounts of government spending for the Vietnam War. At the same time the Fed kept interest rates very low to stimulate growth, many workers had COLAS in their contracts which adjusted for inflation, and a price freeze that was instituted for corporations which had the opposite effect once lifted. However, we learned a lot about monetary policy as Fed Chair Paul Volker raised rates to unprecedented levels and reset inflation to prior levels. Now the Federal Reserve has a much better understanding of what monetary policy can accomplish. They will likely give advanced notice and be very gradual about their policy adjustments in order to keep economic growth moving higher. If you have questions regarding how inflation could affect your investments, please reach out to our office to schedule an appointment.
The views expressed are not necessarily the opinion of LPL Financial. Due to volatility within the markets mentioned, opinions are subject to change without notice. All investing involves risk including the potential loss of principal. No investment strategy including buy and hold, and diversification can guarantee a profit or protect against loss in periods of declining values. Past performance is no guarantee of future results. Please note that individual situations can vary and therefore should only be relied upon when coordinated with individual professional advice. This information is not to be taken as Investment advice or guarantee of future results.
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