Should You Be Worried About Inflation?
We had quite the year in 2020. Masks, social distancing, and TikTok dominated many of the headlines. In 2021, we are still feeling the aftermath, particularly when that comes to inflation. The Biden administration is wrestling with how to proceed legislatively, and inflation is an enormous factor they are considering. After the country spent trillions of dollars combating COVID-19, a major side effect of that battle is inflation. I am often asked, “How much inflation can the country afford before we’re in trouble?” Let’s talk about some of the basics.
If you have noticed the price of a thing increasing over time (say, a gallon of gas or the cost of college tuition), that’s inflation. Economists use the broad increase (or decrease) in prices of goods and services across the country as a measure of economic health. When inflation is stable and predictable, it’s a sign of a healthy, growing economy. High inflation indicates that an economy might be in trouble because inflation can quickly eat away at the purchasing power of your dollars. Deflation, or a decline in prices, can be a warning sign of a shrinking economy.
The data collected from April of this year highlighted a spike in inflation, indicating that prices increased faster than economists expected, according to CNBC. Is this recent data a sign that the recent market surge is ending? Could $50 burgers be in our future? The short answer to that is maybe. On the other hand, could it be a temporary blip caused by the economy emerging from the pandemic-driven slowdown, complicated by supply chain issues? That is very possible as well. Let’s look at the data.
The consumer price index (CPI), one of the major indexes economists use to track inflation, showed a surprising spike in April, igniting fears of runaway inflation. Core CPI (which excludes the highly volatile categories of energy and food) showed a 0.9% increase in April month-over-month and 3% year-over-year. That is much higher than the expected 0.3% and 2.3%, respectively. However, digging a bit deeper, we see that just two categories of goods (used cars and transportation services) accounted for most of the surge. That suggests things like flights and train travel suddenly became more expensive after a year of rock-bottom prices.
Is that runaway inflation or the normalization of prices as the world reopens? We cannot tell from a single data point, but it's not unusual to see prices increase in sectors that experienced a severe slowdown a year before. And the jump in used car prices? Well, many folks are turning to the secondhand market right now, in part because new cars are caught up in global supply chain bottlenecks for things like semiconductors and raw materials. In fact, supply chain issues are impacting several sectors, causing prices to rise. For example, one of my clients who sells semi-trucks for a living is now unable to provide his customers any semis until April 2022. Imagine wanting to purchase a semi for your business and being told it will not be delivered until 2022! Unfortunately, this is a reality for many businesses.
Inflation is something to keep an eye on, especially in a year when so many of the usual variables have been thrown into flux. An ongoing surge in prices could hurt our wallets as our dollars buy less over time. However, a single monthly spike following a weird period for the economy is not cause for alarm just yet, but we should prepare ourselves for more odd numbers coming out of different parts of the economy in the weeks and months to come.
Economists in 2008 expected widespread inflation because of the bank bailouts, but fortunately that never happened. Could history repeat itself? Something much more likely is continued supply chain issues. Shortages of everything from ketchup to gasoline could lead to price increases and fluctuations as supply chains attempt to disentangle from pandemic disruptions.
At this point, inflation is nothing more than a catchy headline and a topic on Capitol Hill. Should we expect markets to react to headlines and those fears? A negative reaction would not be surprising after several months of market performance. Volatility should be expected in the weeks and months ahead as we adjust to a post-pandemic world. The bottom line in all of this is to expect the unexpected in 2021 and prepare yourself and your assets by meeting your financial advisor to be ready for what’s to come.