The Fed Plays Chicken with Inflation
Investors seem to agree with the Federal Reserve that the surges in economic growth and inflation are temporary. I am skeptical. Market pricing indicates most investors expect the growth rate to decline, and that slower growth will reduce inflation. I believe the markets are underestimating the prospects for continued growth and inflation.
Recent economic growth appears to be strong and self-reinforcing. The August employment situation reports gave comfort to slow-growth believers. Payrolls increased far less than economists expected, which they took as a sign the economy is slowing.
Taken with other data, the reports really show employers aren’t able to hire all the workers they need to meet demand. New unemployment claims continue to decline and are approaching pre-pandemic levels.
Unfilled job openings are rising and exceed the number of people who are unemployed and seeking work. Also, wages are rising at a rapid rate. The wage numbers were misleading during the pandemic, because high- er-income workers remained employed while lower-income workers were laid off.
That’s no longer the case, so the rise in wages is real. Another sign that the labor market is strong is the “quits rate” in the monthly JOLTS (Job Openings and Labor Turn- over Survey) report. People quit their jobs when they’re confident of finding new work, or already have found new work, at better pay.
The quits rate rose to its highest level in many years. Household and consumer surveys consistently report that jobs are plentiful. Business surveys report that rapid growth in new orders continues.
The surveys also reveal that businesses continue to have problems obtaining the supplies they need and are paying higher prices for those they can obtain. Business leaders say they are able to pass the price increases on to their customers.
To the extent economic growth and hiring slow, it is because businesses don’t have all the workers and supplies needed to meet demand. I expect strong demand to continue. People are able to obtain jobs and are being paid more to take those jobs. Also, households improved their financial position during the pandemic, paying down debt and increasing savings.
They did this while increasing spending. Businesses are expanding, investing in new equipment and hiring more workers to meet demand. Though the extra pandemic unemployment compensation recently expired, fiscal and monetary policies remain stimulative and will stay that way for a while. Fed leaders talk about reducing the U.S. central bank’s purchases of securities. But it will reduce the liquidity the Fed is pumping into the markets very gradually and will restore liquidity if economic growth falters.
The reported inflation rate probably will decline a bit from the levels reported over the summer, because a few severe price increases, such as for used cars and lumber, exaggerated the monthly inflation increases. But the broad-based and continuing strength in demand and shortages of supplies and labor mean demand will exceed supply.
Most of the supply shortfalls won’t be resolved for some time, putting steady upward pressure on prices. That’s why household surveys show inflationary expectations increased significantly and are a major concern of consumers.
Because of rising incomes and higher savings, consumers haven’t reduced their spending and they likely won’t. They’ll pay the higher prices. We continue to be in a good environment for inflation hedges. Many stocks are highly valued. But stocks of quality companies selling at reasonable prices will continue to do well, as long as there is liquidity in the economy and growth continues. Traditional bonds and cash remain unattractive.
Real yields (the market yield minus inflation) haven’t been this low since World War II, leaving no margin of safety. I continue to recommend a diversified portfolio of inflation hedges, selected global stocks and preferred securities.
