“The American people have a love-hate relationship with inflation. They hate inflation but love everything that causes it.”
— William E. Simon, American businessman and philanthropist who served as the 63rd United States Secretary of the Treasury
On Friday, we learned the personal consumption expenditure (PCE) price index was up 3.6% year-over-year in April. The core PCE price index, which excludes food and energy, was up 3.1%, the biggest jump in this index since 1992. Similar to how they reacted to the April consumer price index (CPI) report, economists were quick to note this increase was largely due to temporary anomalies tied to the pandemic. In the U.S., we continue to move through the near-term surge in inflation as COVID-19 unwinds, and services spending and inflation, in particular, continue to catch-up from depressed levels.
However, assertions that the current bout of price volatility is a transitory phenomenon haven’t soothed consumer concerns that prices may be materially higher down the road. While today’s environment is different, the Fed still insists any uptick in inflation will be “transitory.” The word “transitory” was used nine times in Fed Chair Powell’s April press conference. Fed Vice Chair Richard Clarida said he was surprised by the April inflation report, but maintained the Fed’s transitory line.
Several factors have helped boost spending and hiring over the last year. But, as it turns out, it’s easier to fuel the demand side of the economy than the supply side. Demand is quite strong at a time when supply constraints are preventing manufacturers from meeting demand. Chip shortages are hindering auto production and driving up auto prices. Numerous commodities, including lumber, copper, corn, packaging materials, as well as labor, are in short supply.
The argument that this current inflation is transitory is based on several factors. The above-mentioned supply constraints will eventually ease, relieving bottlenecks and pricing pressure. The Employment Cost Index, which is a comprehensive measure of compensation, has risen but remains generally muted. The Fed is more attuned today than in the 1970s and would more likely hit the monetary brakes in order to meet its longer-term inflation goal, if outsized price hikes continue.
The counter-argument says that this current inflation is more than just transitory, and could have damaging effects to the economy. This is based on the Fed’s monetary policies and other massive government stimulus programs throughout the COVID-19 pandemic.
The Fed insists it will not raise rates until the economy reaches full employment. It’s not yet ready to talk about tapering. The Fed’s super-easy monetary policy allows cash to build up within the banking system—as this lowers interest rates and makes it easier for banks and lenders to loan money. The Fed looks to create easy money when it wants to lower unemployment and boost economic growth, but a major side effect of doing so is inflation.
Massive government stimulus is being pumped into the economy. The United States has embarked on a historic economic experiment. The government has committed in excess of $5 trillion to fiscal support since the pandemic began. This is roughly 25% of the entire pre-pandemic economy. Thus, too much money set to chase too few goods amid strong demand and capacity constraints. Further, the savings rate remains quite elevated, which is likely to support spending even while supply constraints hinder production.
Given all the above, there was always going to be an inflation scare along in here somewhere. The larger question remains: what will be the outcome of this unprecedented economic experiment? And how should the goal-focused, planning-driven, long-term investor—you, our client—deal with it?
Given how much we don’t and can’t know, you have to ask yourself: should I really be making big changes in my investments because of this?
Our approach has always been to first set goals, then make a plan, then fund an appropriate portfolio. Given that your goals haven’t changed, we strongly recommend not changing your plan. And if we’re not changing your long-term plan, then we don’t think we should be tinkering with your long-term portfolio.
You’ll note that this tactic—stressing the unknowability of any future apocalypse versus the soundness of your long-term plan—isn’t just a way of dealing with the specter of increased inflation. It’s the way of dealing with the gauntlet of other economic and market uncertainties that from time to time will come our way for the rest of your lives.