There’s no putting it off. We have to try to make some sense out of the surge in inflation we see up close and personal, at the grocery store and the gas pump, and the divergent but clear indication coming from the bond market which is saying “What Inflation?”. So. Which is it? I believe a bit of both.
I hear from economists and experts of various stripes that we have several sources of inflation, some f which will fade with a diminishing of COVID, and other sources which will remain to push or keep inflation up. For both of these categories, we have to ask – when and by how much.
Links in the chain
Much of the inflation we see recently reported at a multi-decade high is due to pandemic related dislocations in the “supply chain” of items moving from one manufacturer of component parts to the next “link” in the chain of the manufacture of the car or washing machine, increasing just a little bit in cost – because they can – before that car or appliance arrives in showrooms.
These same links in the supply chain can be found in the food industry as our food passes from growers through transportation and final delivery of food products to the ultimate point of sale, grocery store shelves, again costing a bit more at every link in that chain because scarcity allows price increases to be accepted.
Supply chain dislocations are expected to remain with us only as long as labor shortages and dislocations remain as a result of the pandemic. Hence, they are deemed temporary. How long is temporary? We can’t answer that until we know how long it will take to suppress COVID back to something manageable. However, for purposes of understanding the current state of “Inflation,” we believe this Supply Chain dislocation inflation will subside in time.
Wage Inflation is another matter
This is “sticky inflation”. So, do we have Wage Inflation? Certainly, we don’t have the wage inflation of the 1970’s variety. Wages for hourly workers have risen as employers compete for workers, but these increases appear to be modest. There remain over three million workers out of the workforce due to COVID, and as they are able to return to work wage pressures should ease.
Cost of housing is the other large contributor to inflation which is “sticky”.
Cost of housing makes up almost 38% of the calculation of headline and core inflation. Both new and existing homes are selling at rapidly inflating prices, and this trend effects rental rate renewals in a kind of Housing Supply Chain inflation. This one, however, is not thought to be temporary in the same way as manufacturing Cost of Goods. Housing and rental prices may pull back as the pandemic also pulls back, but together with gains in wages these “sticky” bits of inflation are likely to contribute to inflation settling into a slightly higher “new normal.”
Back to the bond market’s signals
We can look at the longer-term Treasury interest rates to see what the Fixed Income markets expect to receive as a reasonable rate of return over time. The bond market is telling us 2% to 3% is OK by them. This should signal to us that inflation is not spiraling up over any meaningful time frame.
The views stated in this letter are not necessarily the opinion of Cetera Advisor Networks LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change with or without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results. Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing.
The return and principal value of bonds fluctuate with changes in market conditions. If bonds are not held to maturity, they may be worth more or less than their original value.