Digging Deeper into Inflation Fears

May 26, 2021 |
2 minute read
|

The current debate about whether the spike we are seeing in inflation is “transitory” should be reframed as “reflation vs sustained inflation.” Just like many other economic data points (ISM, confidence, employment) the recent inflation measures represent a resurgence from the mid-pandemic lows and a positive sign of economic recovery. We believe it is also short term and should not be misconstrued as the long run intention of the Federal Reserve’s actions.

The dual mandate of the central bank is employment and price stability. It has been very transparent with the price stability target and its goal of reaching sustained inflation averaging 2-2.5 percent over time. April’s 0.8 percent increase is well over the target, but it is mostly in the “transitory” reflation category. It is important to be clear: reflation doesn’t mean high inflation. The “transitory” reference puts an implied cap on higher inflation prints. It assumes near term inflation will be driven by the base effects of the deflationary economic environment in the second quarter of 2020, at the onset of the pandemic, and inflation will subsequently settle back to the long run averages. However, investors should also recognize that the long run outcome of the Fed’s actions (if they work) will result in sustained inflation above the averages we have seen for the last 10-20 years.

It is expected that the second quarter will show seasonally high inflation even with minimally high increases over last year. The monthly inflation prints for March, April and May 2020 were -0.3, -0.7 and -0.1, respectively. The combination of simple math and widely known inflationary factors (disrupted supply chains, commodity prices, labor market inflation, Fed action) were bound to have an impact. Even if April CPI had increased at the consensus 0.2 percent, the headline number would have accelerated to 3.6 percent. Instead, April printed 4.2 percent which is the highest since August 2008. The same may hold true for May.

The components of the report highlight a combination of supply issues and economic reopening. Used cars prices were up nearly 10 percent reflecting shortages and stimulus checks, while increasing mobility boosted some sectors including hotels (8.8 percent) and airfares (10.2 percent). It also should be noted that traditional measures of inflation may not be appropriate as lifestyles have changed over the last 12-18 months. Headline inflation data is likely not capturing what the consumer is experiencing. The basket of goods used for CPI suffers from lack of substitution and does not represent all production and consumption in the economy. Going forward, accelerated labor costs (wage inflation) could present an economic hardship for businesses trying to recover - particularly businesses that require low skilled labor and have price inelasticity.

This may be a wake-up call to the Fed and perhaps it will take this opportunity to lay the groundwork for more sustained inflation further into the recovery. Ultimately, that may not be the case and regardless of how high the numbers get over the next few months they will continue to be dismissed as temporary by central bankers. We believe the focus will remain on the employment part of the dual mandate. As Chairman Powell noted in his last press conference, “payroll employment is 8.4 million below its pre-pandemic level, and this figure understates the shortfall in employment as participation in the labor market remains notable below pre-pandemic levels.”

As we moved past the first anniversary of the onset of the pandemic the lagging impacts of COVID-19 were still dictating many aspects of daily life. On a positive note, there is tangible evidence that the situation is improving both from an economic perspective and, perhaps more importantly, from a quality of life perspective. As we proceed through 2021 increased mobility will lead to an increasingly active consumer and businesses seeking to recover and expand will continue to make capital investments. However, post-reflation challenges will remain. Simply getting back to 2019 economic benchmarks is in process but the taller task will be laying the fundamental groundwork for sustainable and equitable economic growth in 2022 and beyond.

Ryan Driscoll

Author

Ryan Driscoll

Managing Director

Disclaimer

Certain information contained herein has been obtained from or is based on third-party sources and, although believed to be reliable, has not been independently verified. Such information is as of the date indicated, if indicated, may not be complete, is subject to change and has not necessarily been updated. No representation or warranty, express or implied, is or will be given by The Common Fund for Nonprofit Organizations, any of its affiliates or any of its or their affiliates, trustees, directors, officers, employees or advisers (collectively referred to herein as “Commonfund”) or any other person as to the accuracy or completeness of the information in any third-party materials. Accordingly, Commonfund shall not be liable for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on any statement in, or omission from, such third-party materials, and any such liability is expressly disclaimed.

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To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated herein. Forecasts of experts inevitably differ. Views attributed to third-parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Market and investment views of third-parties presented herein do not necessarily reflect the views of Commonfund, any manager retained by Commonfund to manage any investments for Commonfund (each, a “Manager”) or any fund managed by any Commonfund entity (each, a “Fund”). Accordingly, the views presented herein may not be relied upon as an indication of trading intent on behalf of Commonfund, any Manager or any Fund.

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Disclaimer

Certain information contained herein has been obtained from or is based on third-party sources and, although believed to be reliable, has not been independently verified. Such information is as of the date indicated, if indicated, may not be complete, is subject to change and has not necessarily been updated. No representation or warranty, express or implied, is or will be given by The Common Fund for Nonprofit Organizations, any of its affiliates or any of its or their affiliates, trustees, directors, officers, employees or advisers (collectively referred to herein as “Commonfund”) or any other person as to the accuracy or completeness of the information in any third-party materials. Accordingly, Commonfund shall not be liable for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on any statement in, or omission from, such third-party materials, and any such liability is expressly disclaimed.

All rights to the trademarks, copyrights, logos and other intellectual property listed herein belong to their respective owners and the use of such logos hereof does not imply an affiliation with, or endorsement by, the owners of such trademarks, copyrights, logos and other intellectual property.

To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated herein. Forecasts of experts inevitably differ. Views attributed to third-parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Market and investment views of third-parties presented herein do not necessarily reflect the views of Commonfund, any manager retained by Commonfund to manage any investments for Commonfund (each, a “Manager”) or any fund managed by any Commonfund entity (each, a “Fund”). Accordingly, the views presented herein may not be relied upon as an indication of trading intent on behalf of Commonfund, any Manager or any Fund.

Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Fund. Such statements are also not intended as recommendations by any Commonfund entity or any Commonfund employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information or statements. Past performance is not indicative of future results. For more information please refer to Important Disclosures.