Inflation isn’t a tangible thing so it’s difficult to spot right away, but over time its presence becomes more and more noticeable. What we once spent at the grocery store doesn’t go as far, cars seem to cost more, there’s more pain at the gas pump, and the list goes on.
The word itself brings out a negative feeling in most people. If you lived through a period where inflation was high, like in the mid-70s or early-80s, you probably have a few inflation-related stories yourself, maybe about gas prices or maybe you had a double-digit mortgage rate on your house. Inflation always feels personal.
Right now, the inflation rate (CPI) is 5.25%, as compared to 1.31% this time last year. A simple explanation for this is a macro one: coming out of the pandemic the demand for goods and services has been higher than the current supply.
If you’ve been looking to buy a new or used car, you know this to be true. Dealers aren’t getting as many new cars on their lot due to the pandemic-related chip shortages. Prices for new and used cars are up. In some cases, people are paying more for a used car than they would on the newer model, simply because there are no new cars to choose from. Negotiating a deal is dead and dealers have the upper hand because of the supply issues.
It’s also no secret that housing prices are up, look no further than your own neighborhood for this to be true. Shelter, which makes up about 40% of CPI, is mostly composed of rent prices and owner’s equivalent rent (what homeowners think they could rent their house for), so this certainly impacts the CPI number we’re seeing today.
All that aside, inflation isn’t always the monster everyone thinks it is. At reasonable level inflation can spur economic activity. In fact, the US Federal Reserve “the Fed” uses inflation to gauge the health of the economy, and since 2012 they’ve targeted inflation of about 2%.
When consumers believe prices for goods and services will continue to rise in the future, they prefer to buy now rather than later.
As businesses and factories become busier, the demand for labor exceeds the supply. Employers increase wages to attract employees, and at some point, there are fewer unemployed workers to choose from. Some inflation can create a more productive economy.
We’ve been in a period of historically low inflation for more than a decade and haven’t seen any significant spikes in the inflation rate since prior to the ’08-’09 Financial Crisis.
This has been great for borrowers but horrible for savers, in a risk-free sense. Gone are the days when you had a mortgage rate above 4%, but it’s also near impossible to find a savings account that will pay you anything. Most ‘high yield’ accounts are paying something like 0.40%-0.50%.
If we see any sort of sustained inflation, we probably won’t continue to experience the mortgage refinancing craze we’ve seen over the last few years. But on the flip side, we might see some sort of tick up on our risk-free assets.
As discussed in last week’s blog, inflation isn’t always bad news for stock returns either. Some of the most muted years in the stock mark came when inflation was low, not high.
No one can predict the short-term nature of inflation with accuracy and even if that was possible, we’d have to then guess how it would affect markets.
Inflation concerns aren’t new. Prices go up over long periods of time and this is one of the main cases for investing in stocks, to outpace inflation. We’ll see how this plays out but there’s no need to sound the alarm over inflation just yet.