Inflation ... at least we’re not Venezuela
For the past few weeks, we’ve consistently heard the financial markets’ concern over the expected rise in inflation, the year-over-year increase in prices for consumer goods and services. We’ve watched that concern translate to the recent declines and massive price swings in the stock market.
However, inflation is not an inherently bad thing. In moderation, it simply represents a driving consumer demand for goods and services which propels our economy forward. But too much inflation saps economic growth, as both consumers and businesses struggle to keep pace with rising prices. So, how much inflation should Americans be expecting? One percent? Five percent? More?
Fortunately, we don’t experience the same level of inflation as Venezuela. According to the International Monetary Fund, the financial collapse of this South American country sent inflation skyrocketing to 2,700 percent last year. This year, the IMF projects Venezuela’s annual inflation to reach over 13,000 percent! Their currency, the Venezuelan Bolivar, has become so devalued people have resorted to weighing the mountain of currency notes needed to purchase everyday necessities, rather than take the time to count them out.
Yes, inflation here in the U.S. is lower – much lower. The core Personal Consumption Expenditures Index, the Federal Reserve’s preferred measure of tracking inflation, shows inflation at 1.5 percent. Core inflation excludes the more volatile and seasonal food and energy prices. But on Wednesday, the core Consumer Price Index, a secondary measure of inflation that typically tracks higher than the PCE, recorded annual inflation of 1.8 percent.
Regardless of which metric you use, either PCE or CPI, inflation doesn’t currently appear to be excessive. Furthermore, both are below the Fed’s target inflation rate of 2 percent. The Fed judges that a 2 percent inflation rate, over the long-term, is the ideal healthy balance between price stability and economic growth. More importantly, it serves as an anchor, a predictable and defined gauge to reflect the underlying consumer demand for goods and services which drives the American economy.
But according to the financial markets, this is expected to change. You see, having inflation rise to the Fed’s target rate of 2 percent is not the overriding challenge. The challenge is trying to keep it from soaring past the 2 percent mark as our economy continues to surge. Continued strength in consumer and business spending, an exceptionally strong labor market, the return of rising wages and the recently implemented corporate and personal tax cuts are all expected to drive prices higher.
Now, no one is foreseeing a return of the double-digit inflation that plagued our nation in the 1970s-1980s. But the fallout from the Fed keeping inflation in check near 2 percent will result in significantly higher interest rates, which reduces demand for goods and services as the cost of borrowing increases. Though current and projected Fed interest rate hikes are to the benchmark fed funds rate, upon which short-term debt is often based, the markets have also been seeing a sizable pick-up in long-term interest rates. On January 2, the rate on the 10-year U.S. Treasury Note was 2.46 percent. Six weeks later, the rate had shot up to 2.92 percent, a four-year high.
The American economy hasn’t seen an inflation rate of 2 percent since early 2012, but that will likely soon change. The first of four projected 0.25 percent rate hikes this year is expected at the Fed’s next meeting on March 21. The U.S. economy is a robust entity that can withstand its share of punishment. But to temper inflationary pressures without severely damaging economic growth, the Fed will need to gradually apply both the speed and quantity of its rate hikes. The first rate hike of 2018 is just a month away, and already, much is riding on it.
Mark M. Grywacheski, Investment Advisor
Opinions expressed herein are subject to change without notice. Any prices or quotations contained herein are indicative only and do not constitute an offer to buy or sell any securities at any given price. Information has been obtained from sources considered reliable, but we do not guarantee that the material presented is accurate or that it provides a complete description of the securities, markets, or developments mentioned.
Quad Cities Investment Group, LLC is a registered investment advisor with the U.S. Securities Exchange Commission.
