Brad Houle, CFA
Executive Vice President
Fixed Income Research and Portfolio Management
Inflation continues to be in the news and is top of mind for clients. This week, the September Consumer Price Index was reported 5.4% over the previous year, an inflation number well above where it was reported prior to the COVID-19 crisis. The causes of today’s inflation increase appear to be idiosyncratic in nature, such as the upward trending cost of goods and pandemic-induced supply chain disruptions impacting food production and energy costs.
As news of rising costs and worries of inflation grow, media headlines have begun gravitating to a related concern: stagflation[1]. Stagflation is inflation in a stagnant economy, often accompanied by high levels of unemployment. The most recent example in the United States was in the early 1970s. From 1971 to 1974, wage and price controls coupled with an oil shock created a stagflation environment. At the time, inflation peaked at more than 12% and the country was in a recession.
Current stagflation concerns center around elevated inflation coupled with a decelerating economy. According to the Federal Reserve, the 2021 forecast for U.S. real GDP growth is for 5.9%. Real GDP growth is a measurement of growth that takes into account the rate of inflation. Economic growth in the first half of the year was accelerated due to the lingering impact of fiscal spending by Congress in an effort to mitigate pandemic-related employment disruptions. In addition to fiscal spending, the Federal Reserve’s monetary policy has been a tremendous economic stimulus. Now in the second half of the year, growth has been decelerating and will certainly slow further in 2022. The Federal Reserve's real GDP growth forecast for 2022 is 3.8%, still well north of the decade prior.
Our view is that inflation will be greater than it was in the pre-COVID-19 era. Prior to the pandemic, inflation ran between 1%-to-2%. Post-COVID-19, we see inflation averaging between 2%-to-3%. While most of the recent elevated inflation has been transitory in nature, price increases in pandemic-impacted industries and goods, such as used cars, travel, and meals away from home, some of the inflation is in categories that have more “sticky” prices, like the cost of rent. Residential rent increases have a tendency to increase with a lagged effect after large increases in housing prices. The cost of shelter is roughly one-third of the measurement of the Consumer Price Index, indicating that rent increases will be noticeably impactful. That said, 3.8% real GDP growth coupled with 2%-to-3% inflation is not stagflation — it is a robust economic environment.
Takeaways for the Week
Inflation should begin to normalize during 2022 and growth will decelerate next year
This environment should not lead to a stagflation similar to what was experienced in the 1970s
1. “Stagflation,” Investopedia, https://www.investopedia.com/terms/s/stagflation.asp.