The inflation spike we’ve seen over the past several months has been surprising in its magnitude and persistence. Recent readings on inflation have been stunning, hitting heights not seen since the 1970s. In March, the Consumer Price Index rose by 8.5% from the prior year, though some hints in the report suggest we might finally be seeing a peak in the rate of change of prices. The forecasts continue to suggest that inflation should moderate by year-end and into 2023, but that doesn’t take the sticker shock out of the prices we’re paying today at the store and especially the gas pump.
Why has inflation increased so much?
The COVID pandemic badly scrambled supply chains that were already under stress from four years of rising trade tensions and tariffs. The third world countries where much of our goods are produced were hit hard by COVID, interrupting production as factory workers got sick and local efforts to slow the spread of the disease disrupted schedules and shipping. In addition, shipping containers were sent all over the world with supplies to help fight the pandemic. Finally, here at home, dock workers and truckers were hit hard by COVID so there were fewer people available to unload the ships that were allowed into port and get those goods to their destinations.
At the same time, the massive efforts by Congress to support the economy during the pandemic put money in people’s bank accounts that wasn’t being spent on things like eating out or travelling, so most peoples’ spending turned to manufactured goods and projects like home renovation. This economic support, low interest rates and a lot of pent-up demand has meant that American consumers have been on a spending spree for the past year or so.
An excess of demand on top of a constrained supply of goods has resulted in rising prices for the goods that are making it to market. While consumers have recovered their appetite for spending, workers have been slower to return to the labor force. Estimates vary, but there are one million fewer workers in the labor pool today than in late 2019 when the pandemic began. Companies cannot find enough workers to fill the job openings in a red-hot economy and are paying the workers they do have more to keep them. Wage inflation like this is harder for companies to pass through to end consumers, but it does impact how they set prices in the future.
Omicron and Ukraine have compounded the effect
Just as it looked like things might be starting to improve, the Omicron wave hit hard in China and Russia invaded Ukraine, sending food and energy prices skyrocketing. This has contributed to additional increases in energy costs, even though the US has been less impacted than other countries more dependent on oil and gas imports. Global food prices have also been impacted as Russia and Ukraine are two of the largest exporters of wheat.
How persistent will inflation be?
In the meantime, economists debate just how temporary the inflation will be. On the one hand, getting back to something like a status quo would suggest a return to the modest inflation (around 2%) we have seen over the past two decades. A counterargument suggests that aging populations in the U.S., Europe, and China, coupled with immigration restrictions and nationalist policies, could result in significant labor shortages, and keep inflation on the higher end of that range for some time to come.
Persistently higher inflation could result in investors demanding higher interest rates than they have in the past, raising the cost of borrowing across the economy. In addition, expensive growth stocks that benefit from low inflation and low interest rates may lag other stocks that are less sensitive to perfect economic conditions.
So, while Inflation may be a transitory problem, it is still a force to be reckoned with. Left unchecked, it can cause real damage. So, it’s up to central banks to tamp it down, yet not stall the economy in the process. All eyes will be on the Fed as they respond to the inflation surge.
Investors worried about the effect of inflation on their investments or retirement should review their investment objectives and confirm that their financial plan is still positioned to meet them. At Blankinship & Foster, our ongoing guidance helps assure that your plan continues to be relevant to your situation, and to changes affecting your situation such as periods of high inflation.