Will Inflation destroy any chance of an economic recovery?
The recent narrative that inflationary pressure will derail the economic recovery has been a popular topic. And rightfully so. When simply gauging broad headlines tied to how government spending may overburden society on a forward-looking basis, the narrative is one that carries historical significance. Many investors recall the inflationary environment of the 1970s, 1980s, and even in the early 1990s, and can pinpoint the negative economic impact that can often be associated in such an environment. But is it appropriate to assume that the current economic backdrop is headed in a similar direction of a 5-6% annualized CPI (Consumer Price Index)? Our short answer is no. Here is why.
Let us first recognize that marginal and controlled inflation is not bad. It promotes current consumption and allows the economy to sustain a healthy level of capacity utilization. It can also promote innovation and healthy borrowing. The unfortunate consequence of mentioning inflation is that it is often associated with uncontrolled inflation risks that can derail short-term economic momentum. This should not come as a surprise given our normal human nature to often assume the worst-case scenario. The reality is that the current snapshot of inflation does in fact indicate pressures down the road. But such pressures are marginal and well within the range of a 2-4% CPI that the Federal Reserve has outlined as normal. In fact, Fed Chair Jerome Powell has explicitly, and publicly, announced the ability of the central bank to allow inflation to run above 3% for a short period of time before assessing the need to step in. This should be a welcoming fact and not necessarily a run-away risk. The U.S. Consumer Price Index, which measures inflationary pressures, has averaged 1.7% over the past 10 years. That figure grows to an average of 2.1% when looking at it over 20 years. Stated differently, there has been a complete absence of inflationary pressures over the past 20 years in what may be known as one of the most accommodative monetary policy periods in the history of the world. The recent COVID-19 pandemic may certainty change that due to the immense fiscal policy measures taking place, but we should not associate it with a detrimental impact to the economy. Fiscal policy expansion has an ability to increase wealth over the long-term, which may imply a larger taxable asset base for the government to collect taxes on at some point in the future. If we add to that the notion of an economic recovery that is positively associated with growth in businesses, a recovering equity market, and a robust labor market, we should all be in favor of a controlled inflationary backdrop. We should not fear it and must accept the notion that inflation is a must.
For those of you still in the camp that run-away inflationary pressures are likely to become a reality over the next 3-5 years, I urge you to answer these questions. Will the economy likely fully recover over the next 3 years to the point of pre-pandemic levels? Will the equity market likely be higher due to the improvements in consumer spending? Will the labor market look notably better 3 years from now than it does today? If you answered yes in at least 2 of the 3 questions, then you are correctly arguing that inflationary pressures must occur. There is no other way around it. It is a healthy cycle that can sometimes push to the upper limits of what we may feel comfortable with. Given the complete lack of inflationary upside over the past 20 years, the recent fiscal and monetary policy guidelines may be notably more subdued to inflation than what the current narrative may suggest. The idea of accepting the unknown in the current environment is something we must continuously recognize because such a fact may be able to save your retirement.
Edison Byzyka, CFA – Chief Investment Officer – Credent Wealth Management
Investment advice offered through CX Institutional, a registered investment advisor.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. The economic forecasts set forth in the presentation may not develop as predicted.
All return data sourced from Bloomberg.
All other data soured from Bloomberg, through the release of monthly figures from the Department of Labor, Bureau of Economic/Labor Statistics, U.S. Census Bureau, or from the Federal Reserve and any of its affiliated regional locations.
Small Business Optimism sourced through NFIB. Small business hiring plans sourced through NFIB. Consumer sentiment sourced through the University of Michigan.
Earnings data sourced through Bloomberg Intelligence and through Bloomberg’ earnings analysis composites. Interest rate cut/rise probabilities are sourced from Bloomberg’s tracking of futures contracts tied to the Federal Funds interest rate.
Consumer Price Index is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.