Timely and Relevant News: Inflation Data Jolts Investors
For nearly a year, investors have had the late spring/early summer months circled on their calendars for a potential jump in inflation. As mentioned in our recent communication, Inflation Rattles The Market, base effects from rolling off weak data a year ago held the promise of eye-popping year-over-year numbers, along with an economy that would be increasingly reopening. It's no surprise that those two factors could lead to potential inflation.
“Recent data is going to escalate the market’s focus on inflation,” explained LPL Financial Chief Market Strategist Ryan Detrick. “Big beats in inflation data will increase the pressure on Federal Reserve (Fed) Chair Jerome Powell’s characterization of inflation as ‘transitory’ and pull forward calls for tapering asset purchases.”
As seen in the chart below, 10-year inflation breakeven rates - a measurement of intermediate-term market price-based inflation expectations have climbed steadily in the last few months. In fact, breakeven rates are now at their highest level since 2013. The market has digested higher inflation expectations so far without any major challenges to the latest monetary policy guidance. However, given inflation’s tendency to self-reinforce, markets could begin to grow bolder in their demands that the Federal Reserve change course and act sooner
Much of the recent jump in inflation has to do with changes in the supply picture in our estimation, as the base effects and demand pickup were fairly well telegraphed. Surging input costs in supply chains are forcing companies to raise prices. Raw materials such as copper and lumber have been some of the recent high profile culprits. Moreover, signs are pointing to the supply of labor becoming increasingly expensive and difficult to acquire. The most recent employment report showed that workers may require higher compensation to be enticed back into the workforce, especially while enhanced unemployment benefits continue. Finally, supply chain bottlenecks associated with quickly ramping up production are preventing companies from keeping up with surging demand in many cases, which places upward price pressures on existing supply.
While we forecast an inflation jump in the short-to-intermediate term, we do believe that longer-term inflation will remain reasonably well contained. Market-based measures can tend to overshoot in both directions based on prevailing sentiment and we think ultimately that Fed Chair Powell will be successful in preventing inflation from spiraling out of control. As mentioned, restarting the economy creates supply disruptions that feed into inflation, though in time these effects should self-correct. In fact, similar phenomena occurred exiting the 2008 recession, albeit on a more elongated timeline. We anticipate the story will end much the same this time around, but the ride may be bumpy in the meantime.
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