Inflation Worries

Inflation Worries. Prices are rising there is no doubt about that fact. I pointed out that inflation was rearing its head a few months ago as the breakeven inflation rate rose above 2% after plunging during the COVID-19 pandemic. Today, news headlines are talking about inflation more and more. The average consumer is worried about inflation. Inflation reduces your buying power due to rising prices. The same dollar a few years ago buys less today. The U.S. Federal Reserve is also worried about inflation.

Inflation Worries

Inflation Expectations and Worries

In March, the U.S. Federal Reserve indicated that it saw no rate hikes at least until 2024. That outlook has changed. The so-called dot plot of individual member expectations now indicate that a rate hike could come as soon as 2023. But the Federal Open Market Committee (FOMC) did not change its benchmark short-term borrowing rate, which is still near zero.

The Fed also raised its inflation expectations to 3.4% in the June meeting, which is a full point higher than at the March meeting. Stock fell in response and had the worst week since October 2020 because this change was not expected.

The change in outlook has more immediate implications though since it means that the Fed will need to taper its bond buying purchases of $120 billion per month perhaps by end of 2021 or early 2022. If inflation stays elevated the taper could occur earlier. The new stance by the Fed also does not coincide with the view that the spike in inflation is temporary, and that the long-term inflation rate is 2%. But what if the Federal Reserve is wrong? I asked that question in my article in February and it seems like for good reason. The Fed was too conservative in its expectations.

Why Is Inflation High?

The bottom line is that the U.S. economy is growing quickly, which is a good thing. The Fed now sees the Gross Domestic Product growing at 7% in 2021 changed from an earlier expectation of 6.5%. The Fed’s unemployment estimate is still 4.5%. The U.S. economy is expanding at the fastest rate since WWII. Some of this is due to the rebound from the steep COVID-19 downturn and some due to record stimulus during the pandemic.

Businesses increased liquidity and consumers saved money during the pandemic and that money is now being used. We are likely getting more stimulus in the form of the semiconductor stimulus bill and an infrastructure bill. This growth is coming at a cost though as prices are increasing at the fastest pace in 13 years leading to inflation worries.

Consumer prices increased 4.2% in April, which is the fastest rate since September 2008, and was higher than expectations of 3.6%. Some of this can be traced to rising gas prices, used car prices, and rents. The prices of these three items declined during the COVID-19 and are coming off a low base. Key input materials such as lumber, copper, tin, oil, and other commodities are also experiencing higher prices. We also cannot forget the cost of tariffs implemented before 2021, which have the effect of raising prices.

Final Thoughts on Inflation Worries

Should you worry about inflation? Probably not as there is little you can do to control it. But if the U.S. economy continues to run hot with high growth and an inflation rate that is higher than desired it will lead to tapering and eventually a rise in interest rates. Already, some countries have raised interest rates and there may be more hikes to come if inflation stays elevated. A rise in interest rates would mean that your savings accounts and CDs may pay more. But it could also lead to some short-term volatility in the stock market as expectations change. If you are worried about inflation protection, then gold is the classic hedge against inflation, and Treasury Inflation-Protected Securities (TIPS) are also available. However, I am not worried about inflation and personally, I am not changing my focus on dividend growth stocks.