Should we worry about inflation?

Inflation has been making headlines the past couple of months. The discussion is centered around whether we should prepare for lingering higher prices or whether it is merely transitory. Inflation has been rather tame for about 40 years, since it peaked in 1980 at an annualized rate of 13.55%. For the past 30 years, it has been 4% or lower. The most basic explanation for three decades of low inflation is technology. Advances in technology have helped push prices down and made it easier for consumers to find the cheapest goods and services. The most recent reading for the Consumer Price Index (CPI), the most common measure of price changes, came in at 5%, the highest level in over a decade.

It’s worth noting that every consumer’s experience with inflation can be different. Health care expenses and college costs have increased only modestly, and technology costs are basically flat. Energy prices, including gasoline, lumber and both used and new automobiles have seen significant price increases. Those that believe this current bout of inflation is transitory explain that the pandemic and the pent-up demand that it created is behind the price spike. While stuck at home, people made the decision to complete renovations on their homes resulting in increased lumber prices. Now that workers are getting ready to return to their offices, they are replacing their older vehicles. During the pandemic, demand for leisure, travel and retail was crushed and now these sectors are coming back to life.

Another inflationary effect of the pandemic has to do with employment. Many displaced workers began receiving federal benefits that exceeded their previous salary and created a disincentive to return to their jobs. Employers in turn were forced to raise pay which allowed workers to save more which then allowed retailers to charge more for their goods and services. After this initial post-pandemic spike and the continued advances in technology forcing prices lower, the transitory inflation argument seems to make the most sense. Many economists and strategists also argue that a persistent increase in wages is needed for inflation to continue its climb. This has yet to be confirmed by several wage-tracking metrics such as the employment cost index or various business surveys. There is also evidence that supply chain pressures that were behind the rise in lumber and other commodity prices has eased. There were also reports that prices in wholesale used car auctions had peaked, suggesting that retail auto prices may follow.

As outlined above, the case for transitory inflation seems likely and prices should settle after the initial post-pandemic spike. We are monitoring the situation closely and if we believe inflation will become a more persistent concern, we will be adjusting client portfolios accordingly.

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