Inflation continues to be one of the economy’s biggest financial concerns. Gasoline is at a 7-year high and a dollar a gallon more than last year at this time. Grocery prices are rising rapidly with many items up 10%.
Economist look at inflation in different ways. Core inflation tracks prices of goods and services. Interestingly, core inflation including shelter, household furnishings, apparel, transportation, medical care and recreation. Surprisingly it does not include food and energy inflation. When these are included, it becomes the consumer price index. In June, this index rose 5.4% representing the largest 12-month increase in 13 years.
This situation should have been predictable. During the pandemic many things changed in the economy. There was unprecedented financial stimulus given. People could not go on vacation or eat out, so they purchased many home furnishing, exercise equipment, home office supplies and other things. This demand combined with shut downs at Asian factories caused disruptions to the supply chain. Also, because many people received more income than they would from their jobs, savings increased which meant this artificial demand would continue for a while. This all contributes to inflation.
The FED like most national banks likes to see inflation of about 2% a year. At that rate most people looking for jobs can find employment, people can afford to buy their needs and repaying government debt is a little bit less expensive. Chairman Powell has been saying that he is not concerned because he sees inflation as transitory meaning short term. The FED has recently had to admit that inflation may last longer possibly extending well into 2022.
Historically the FED has watched for signals from the bond market to expectation of future inflation. Bond buyers want to earn yield or interest in line with expected inflation. Recently five-year rates touched 3% which is known as break even. When expenses such as wage rates and rental rates are increasing. These usually are more long-term indicators of what will happen with interest rates.
Lawrence H Summers an economist in the Clinton and Biden administration recently told the New York Times, that the stimulus bill signed in March was too much, he says “inflation now risks spiraling out of control.” “The original sin was an oversized American Rescue Plan. It contributed to both higher output, but also higher prices,” said Jason Furman, a Harvard economist who chaired the White House Council of Economic Advisors under President Barrack Obama. Yet, Washington continues to try and spend trillions more.
Next week the FED will discuss what they need to do. They have hinted there could be a slowdown in their bond purchases. They have been pumping $120 billion into financial markets every month since the pandemic started. This has allowed huge amounts of money to flow into the stock market. What happens when the FED starts to reduce this abnormal and excessive liquidity? Time will tell.
Make sure that your financial plan accounts for all of these upcoming changes. Inflation is going up as are interest rate. The deficit is growing and there will be big changes in liquidity. Since the Great Recession in 2008-09 we have been living in the perfect environment for stocks. Make sure your allocations match your risk tolerance and time line. We may have been spoiled by the last decade.