U.S. Inflation – CPI Year over Year Percentage Change
Source: FactSet, U.S. Bureau of Labor Statistics. May 2011 to April 2021
Thoughts on Inflation
U.S. inflation has been a hot topic this year, and rightfully so, as historic fiscal stimulus programs, ultra-accommodative monetary policy and an economy moving ever closer to self-sustaining status nudged inflation expectations higher. The most conspicuous evidence on this front comes in the form of the U.S. Bureau of Labor Statistics’ May report depicting a 5.0% year-over-year increase in its Consumer Price Index (CPI); the largest increase since 2008. The less volatile Core CPI measure, which excludes food and energy components, also rose a noteworthy 3.8% over the same period. While these figures certainly capture our attention and scrutiny, much of the increase over the last year can be attributed to a low base effect, as recent data solidifies from the unsustainably low levels witnessed in the spring of 2020 following the essentially complete shutdown of the economy in response to the COVID-19 pandemic. Commodity prices plummeted in the immediate wake of the pandemic as consumers stayed home and businesses closed, but they have staged a steadfast recovery since then in anticipation of a global recovery. Supply chain disruptions (blocked canals, pipeline hacks, etc.) also impacted prices across industries but are beginning to show signs of being addressed and alleviated. Charles Schwab recently noted that shipping from Shanghai to Los Angeles has been taking more than double the typical 14-day journey, ports are now showing less backlog and the Baltic Dry Freight Index (which measures bulk material prices across popular global shipping routes) has moved off its peak earlier in the month
Velocity of M2 Money Supply
Source: FactSet, Federal Reserve. June 1971 to March 2021
U.S. Money Supply and Velocity
The Federal Reserve has largely viewed the recently heightened inflation data to be transitory and remained firmly committed to its existing cohort of policies and stances while letting inflation run above its long-term target of 2% in a bid to not prematurely extinguish the economic recovery. Slack in the labor market persists as unemployment rates remain elevated and the number of employed sits well below pre-pandemic levels, conditions which should hinder inflation from rising to troubling levels near term. Unprecedented monetary and fiscal stimulus over the past year has injected liquidity into the system and is, indeed, a potential catalyst for higher inflation longer term. We also note that U.S. M2 money supply peaked at 27% in February from a year earlier, yet the velocity of money – the number of times one dollar is spent to buy goods and services per unit of time – is at its lowest level in 50 years and serves as one gauge that the recovery still has a way to go. Short-term inflation will likely trend higher as we cycle off the 2020 lows and we expect may run at a higher rate compared to subdued pre-pandemic levels. We remain of the mindset that all things equal, inflation is unlikely to take hold at a level that would serve to derail the recovering global economy. An allocation to a diversified pool of real assets can be an appropriate and effective way to protect portfolios from the potentially damaging repercussions of inflation.