by Blaine Dickason
Senior Vice President, Trading and Fixed Income Portfolio Management
Inflation expectations are rising. Next month, we begin to lap the extraordinarily low inflation measured last year when the pandemic triggered a dramatic reduction of demand for both goods and services globally. Upcoming reports may be elevated when compared to last year’s weak results and we may see 3 to 4 percent increases in inflation this spring. While these higher readings are very likely and may result in alarmist headlines, they are also well expected by market participants. Perhaps more importantly, the Federal Reserve has already stated they view these higher rates as transitory in nature. The more important question is if the unprecedented stimulus to offset the pandemic will usher in a new era of persistent inflation after over three decades of disinflationary pressures in the U.S. economy.
Inflation can be viewed as the general rise in the price level in an economy over time. Many of today’s fears of escalating prices are rooted in the experience of the 1970s when residential mortgage rates and the Consumer Price Index (CPI) were solidly in double digits. Fears of a repeat of that decade have prompted many dire forecasts that have all failed to materialize. Increasing productivity, globalization, and demographic trends have all contributed to inflation remaining in check, as can be seen in the graph below.
Source: Bloomberg
After the Great Financial Crisis, there were predictions for runaway inflation as governments and their central banks leveraged new policy tools to stimulate the economy. Immediately preceding the current pandemic, the U.S. economy boasted a low 3.5 percent unemployment rate and 10 million more wage earners than at present. In neither case did the dynamic of too much money chasing too few goods cause inflation to rise to meet either the Fed’s target or market expectations. Supply chain disruptions and bottlenecks can still lead to short-lived inflation; however, capacity tends to expand to match new demand and persistent inflation is avoided.
We view the increase in interest rates and inflation expectations thus far this year to be healthy signs of an economy getting back on its feet. In other words, yields are going up for the right reasons.
Week in Review and Takeaways for the Week:
U.S. retail sales in January increased by 5.3 percent from the prior month for the strongest monthly gain in seven months
Building permits issued for new construction in January grew to the highest annualized rate since 2006