Saturday, February 13, 2021

Is Inflation Just Around the Corner?


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The Bureau of Labor Statistics released the January Consumer Price Index (CPI) report this week. CPI is a measure of inflation at the consumer level. CPI rose1.4% year over year. I know, it's thrilling! It seems people either yawn at this number or don't believe it accurately reflects what's going on in the real world.


So, what is inflation, and why is it something we need to watch right now? Inflation is an increase in prices or a fall in the purchasing power of money. Some believe that Washington's response to the Financial crisis and actions by the Federal Reserve will be inflationary.  


Congress has charged The Federal Reserve (The Fed) to use monetary policy to maintain maximum employment and stable prices. The Fed has many financial tools to help it achieve these goals, most notably adjusting interest rates and controlling the money supply. The Federal Reserve has set a target inflation rate of 2% with the belief that 2% is the rate most likely to produce financial conditions to achieve its goals. Despite their accommodative interest rate policy and bond-buying programs, 2% inflation has been elusive. 


The market interpreted the recent CPI report of 1.4% as giving Congress and The Federal Reserve cover to move forward with the planned $1.9T economic relief plan. However, I think a more in-depth look at the data and the world around us may be telling a different story, and inflation may be just around the corner.


CPI is a combination of inflation rates from different categories of economic activity. When we look where inflation is and where it isn't, I see the potential for a rise in inflation in the coming months. Used car prices rose by 10% as people began traveling more by car than by airplane. We saw an increase in the cost of food, utilities, and most other economic categories. Those increases were offset by decreases in prices of Airfare, Gasoline, and Energy. These are areas that we would expect to see prices rise as more people are vaccinated and reengage with the economy.


Since the Financial Crisis in 2009, the Federal Reserve has kept interest rates low, expanded the money supply and its balance sheet to encourage economic growth in pursuit of its Congressional mandate. Historically there has been a direct correlation between an expansion of the money supply and CPI. As the country emerges from the slowdown caused by the Pandemic, the Federal Reserve may need to turn its attention to price stability should inflation quickly exceed its 2% target. However, after more than a decade of aggressive monetary policy inflation has remained tame. I'll be paying close attention to future reports. Should inflation begin to accelerate, we would want to position investment into the areas that would benefit from rising inflation.