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Inflation is there. The question is how long will it last.
The Biden administration and Federal Reserve believe the price hike will be transient, but have resorted to random estimates when asked for details.
Treasury Secretary Janet Yellen recently said there would be “high rates of inflation until the end of the year.” This sentiment was echoed by San Francisco Federal Reserve Chairman Mary Daly, who gave a similar timeline. Richmond Fed Chairman Thomas Barkin and Fed Governor Lael Brainard said high inflation would persist essentially through the summer, while Fed Vice Chairman Richard Clarida simply said it would “take a while” to get back to normal.
This latest opacity is in line with President Jerome Powell’s thinking: since last August, he has reiterated that the Fed will allow prices to rise above the central bank’s 2% target rate “for a modest period” before moving to l ‘action.
But there has “been no real discussion on how transient this period is or where consumer price inflation might normalize” once prices of Covid lockdowns lower. past year disappeared from year-over-year inflation calculations, noted Leuthold’s chief investment officer, Doug Ramsey. .
With stock prices near all-time highs and bond yields at historically low levels, investors don’t seem to care, and perhaps consumers, who are so anxious to get back to their ostentatious pre-Covid consumption. , won’t care that their restaurant bill is a few dollars more expensive.
But that’s just the start, and people’s tolerance for higher inflation than we’ve seen for decades may erode as the experience continues. With an unemployment rate still well above what it was before the pandemic, the Fed is in a difficult situation. How he reacts will ultimately affect your wallet.
Why is inflation increasing?
No matter how you look at it, the prices are climbing fast.
The widely disseminated Consumer Price Index (CPI), for example, showed that the cost of a collection of everyday consumer goods rose 4.2% in April from a year earlier, the gain largest annual since 2008. The Federal Reserve’s preferred inflation indicator, hence called the core personal consumption expenditure (PCE) price index which excludes volatile food and energy prices, gained 3.1% in April 2021 compared to April 2020, a level not seen since May 1992.
But it’s difficult to compare prices today with April 2020, when Covid-19 first struck and economies shut down in an attempt to prevent hospitals from overflowing.
Take the plane tickets. If you compare April 2021 to March 2021, air fares have gone up 10.2%, which is pretty crazy. However, plane tickets are much cheaper today than they were in January 2020. Over time, this so-called “base effect” should wane.
But some industries have grown massively, even from their pre-pandemic levels, in large part due to supply limitations boosted by Covid-related shutdowns. Car prices, for example, have increased in part because a shortage of chips caused a shortage of new cars, thus increasing the demand for used cars. Meanwhile, the pandemic prompted many rental companies to downsize their fleets last year, so the supply of used cars is much lower.
Home prices are skyrocketing for similar reasons: mortgage rates are really low, more people are staying in their homes longer, and there aren’t many new homes for sale. Add a subtle change to remote working and thousands of direct payments to plenty of people who never lost their income, and you’ve set the stage for inflation.
That said, the Fed expects businesses to resolve these supply issues as the economy reopens, helping to contain inflation.
Why the Fed matters
As Powell constantly reminds anyone who will listen to it, the Fed has two tasks: to maximize employment and to keep prices stable.
In April, the unemployment rate was 6.1%, much higher than the level of 3.5% on the eve of the recession. Millions of people remain out of work and many sectors of the economy, such as restaurants and hotels, are only finally returning to business.
This is why the Fed has embarked on an easy money policy: interest rates close to zero and monthly purchases of $ 120 billion of bonds. The central bank believes employers need cheap money to expand and hire more workers.
Ultimately, however, the Fed will have to tighten the tap. The minutes from the last Fed meeting revealed that some members of the Federal Open Markets Committee wanted to talk about the possibility of slowing the pace of bond purchases going forward.
Which means that the Fed is more interested, right now, in cleaning up the labor market than in dealing with inflation.
What it means for you
Some consumers who postpone large purchases during economic lockdowns may be surprised at the cost of some large items. It’s okay to say that something unpleasant will only be short lived, but those who endure the annoyance might not take your word for it in real time.
“Our best read is that a mindset of scarcity and worries about inflation could shake [consumer] trust for a while, ”reads a note from economists at Wells Fargo Securities.
Talk to normal people and you will hear their legitimate concerns that inflation is already out of control, at least as far as their lives are concerned. Nonetheless, these Wells Fargo Securities experts believe there will still be “robust consumer spending in the months to come, especially in the leisure categories, which have the most room for growth.” In other words, people will pay a premium to satisfy pent-up desires, such as for travel and dining.
On the investor side, Ethan Harris, head of global economic research at Bank of America, expects the 10-year Treasury yield to drop from around 1.6% today to around 2, 15% by the end of the year, with market participants selling some of the government debt as inflation rises. . (Bond prices and yields are inversely related.) This is getting closer to where the yield was in the spring of 2019.
While demand for bonds may suffer as higher inflation holds for a short time, stock purchases are expected to rise further as investors take more risk to outpace price gains.
Sam Stovall, chief investment strategist at research firm CFRA, expects the S&P 500 to gain around 10% over the next 12 months “as the global economy continues to emerge from the Covid crisis” .
This zest for life, however, can be tempered by “lingering worries about inflation and interest rates,” notes Stovall.