April 23, 2021

How to Think About Inflation Today

By Michael McKeown, CFA, CPA - Chief Investment Officer

How to Think About Inflation Today

Home prices are surging. Prices of cars are through the roof. Bottlenecks in supply chains are pushing prices up across the board. Finding new employees is a commonly cited challenge for businesses across industries.

Checking deposits

Expectations for short-term inflation just hit a 9-year high at 3.7%, though longer run expectations remain stable compared to the past.

Checking deposits

Because inflation was so low last year, economists predict the next few months will have high inflation data points. These are due to “base effects” of the recession last year.

Yet price increases at this rate were not durable following recessions in the past. Core inflation measures took several years to bottom following the last four recessions. Note the red arrows in the chart below.

Checking deposits

Economists have a nerdy definition of what inflation is.  We can quibble with it. But the reason it matters is that’s what the Federal Reserve cares about.  And the Fed’s Open Market Committee sets interest rates.  Markets around the world care about interest rates because financial and real assets use interest rates as an input for pricing.

Economists care about the long-run trajectory of sustainable inflation.

Inflation today is considered transitory – meaning, the supply problems we are seeing across industries are a result of the recession and pandemic. These are not considered multi-year issues at this stage. 

That means inflation expectations should come back down to earth.

What would sustainable inflation look like?

It would likely be a result of perpetual fiscal stimulus.  That could come in the form of government fiscal spending or the flip side, much lower tax rates. Both forms would put more money in the private sector at the expense of the government sector running a deficit.  More money chasing more goods and services.

At this stage, the fiscal stimulus programs are temporary.  In addition, tax rates will not be going down any time soon.

Inflation is a hard concept to fully project. There are so many factors that affect it.  And even then, it may not come to fruition.

Japan is the poster child for this.  Since the late 1990s, Japan enacted programs to keep a lid on interest rates. It also ran large fiscal deficits.  For years, economists predicted runaway inflation and interest rates. Yet, today Japan’s interest rates are around 0% and inflation is still tame.

The Japanese economy “paid for” this with a depreciating currency.  While one may point this as a bug in the system, it may actually be a feature.  Sustaining positive incomes, employment, and business growth at the expense of a slow decline in purchasing power may be more palatable than the alternative.

A depreciating currency forces investors that who want a satisfactory return to invest in equities, fixed income, or real estate.  Thus investors are pushed further out on the risk spectrum.  We are also seeing the extreme of this – highly volatile speculation in certain asset classes.

Inflation will be a topic du jour for the next several months.  Yet there are so many factors to think about as to whether it represents a true, long-term shift. It will be important to watch how policy evolves.

Important Disclosure Information

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Marcum Wealth, or any non-investment related content, made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from Marcum Wealth. Please remember to contact Marcum Wealth, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. Unless, and until, you notify us, in writing, to the contrary, we shall continue to provide services as we do currently. Marcum Wealth is neither a law Firm, nor a certified public accounting Firm, and no portion of the commentary content should be construed as legal or accounting advice. A copy of the Marcum Wealth’s current written disclosure Brochure discussing our advisory services and fees continues to remain available upon request. Please advise us if you have not been receiving account statements (at least quarterly) from the account custodian.

Historical performance results for investment indices, benchmarks, and/or categories have been provided for general informational/comparison purposes only, and generally do not reflect the deduction of transaction and/or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results. It should not be assumed that your Marcum account holdings correspond directly to any comparative indices or categories. Please Also Note: (1) performance results do not reflect the impact of taxes; (2) comparative benchmarks/indices may be more or less volatile than your Marcum accounts; and, (3) a description of each comparative benchmark/index is available upon request.