Inflation in the United States increased in April to 4.2% and spooked markets in May. While the Federal Reserve believes this to be transitory, some financial news points to a shifting regime.
Here is how we see things
The first step is understanding why this is happening, which sectors are driving overall inflation and how sustainable the new prices are.
Many factors go into calculating the inflation numbers. The ones that had the most impact are:
- The Energy sector -representing over 25% of the inflation measure- has had a significant increase in prices over the past year. For example, in April 2020, Crude Oil was hovering around $25 and is now closer to
$60 a barrel. - Used vehicles also climbed a surprising 21% due to supply constraints.
- Restaurants and Fast Food increased by 3.8%, as the re-opening of the economy has led to a significant increase in demand.
In addition, because the pandemic restricted many industries, we are coming off a low comparison base.
Here is how we see things developing
Short Term: In the Short Term, inflation may continue to run hot in 2021. As things stabilize and snap back. Even an overshoot in some prices and industries is to be expected.
Medium Term: Assuming we reach some type of normalization by 2022, demand and supply-side inflation should stabilize in the medium term. Different types of demand will be spread out.
- Some demand was pulled forward (think about things like construction and home renovations).
- Some demand was destroyed (we can’t make up for missed events like hockey season and family gatherings).
- Some demand is pent up (for example, new vehicle purchases may create a spike later in the year but should adjust over the mid-term).
Long Term: Deflationary secular trends will resume. Some of these trends include:
- An ageing population, which commonly means a decrease in general demand.
- An increased productivity from new and better technologies
- And many emerging markets are starting to mature, which also means slower growth and lower inflation
It’s impossible to know where inflation will stabilize over the long term. However, governments are comfortable letting it run over 2% or getting to full employment without making significant adjustments to the interest rates, which is what the financial markets react to at the end of the day.
The Key Takeaway
While it’s likely that inflation will remain higher in 2021, there are many indications that it will be transitory. Inflation coming from rebounding industries like restaurants and hospitality is welcome, and keeping inflation expectations in check is also important.
Overall, our strategy of investing in long-term growth trends will not be affected by headline inflation numbers, and we have structured our portfolios with this environment in mind.
On behalf of the TWM Group, thank you and see you next time.
