Inflation Update | June 2021

2021 Theme:  Above Trend Economic Growth

• Due to the progress of vaccinations and the potential release of pent-up demand, a surge of economic activity is expected in the second half of 2021.
• In 2021, the US is likely to have its highest level of economic activity in decades.
• Improvements in growth expectations, unprecedented levels of fiscal and monetary stimulus, and supply chain shortages have created price pressures that have accelerated in 2021.

Service Inflation and Goods Inflation

• Reasons for price inflation:
  • “Base Effects”: Recent inflation readings incorporate depressed price levels from the economic shutdown in Spring 2020.
  • Strong demand for goods as a result of monetary and fiscal stimulus.
  • Short supply due to labor and production shortages that resulted from shutdowns and government policy.
• Prices for goods, which tend to be more volatile than services, have increased substantially over the past year.
  • Durable goods prices (automobiles, appliances, etc.) have increased by more than 5% over the past year.
  • Non-durable goods inflation (clothing, household products) have increased by more than 4% over the past year.
• Prices for services have increased over the past year as well, but not to the same extent as prices for goods.
• In the months ahead, goods inflation is likely to soften while services inflation is likely to accelerate.

The Federal Reserve’s Dual Mandate

• The Fed uses its monetary policies to achieve its dual mandate of:
  • Full employment
  • Price stability
• Monetary policy is likely to remain very accommodative until unemployment reaches 4% and long-term inflation trends near 2%.
• Over the short term, the Fed’s target for inflation will be closer to 2.5% to make up for low inflation that occurred since the financial crisis.

Takeaways:

• The Fed may begin to unwind its quantitative easing program as inflation ticks higher and unemployment improves.
• The Fed is unlikely to increase its policy rate until inflation and unemployment levels reach the Fed’s target.

The Federal Reserve’s Order of Operations

• To reduce inflationary pressures in the economy, the Fed will begin to tighten its monetary policy.
• The first step the Fed will take to tighten monetary policy will be to “unwind” its quantitative easing program.
  • The Fed may discuss its plans during the Jackson Hole Conference in August 2021.
  • If current trends in unemployment and inflation continue, it is likely that bond purchases begin to slow in late 2021 or early 2022.
• The second step in tightening monetary policy will be for the Fed to raise its short-term policy rate.
  • The Fed announced plans to begin raising short-term interest rates in 2023.
    • This announcement was an acceleration of the Fed’s original plan to begin raising interest rates in 2024.

Consumers Are Beginning to Change Spending Plans

Plans to Buy a Home Index

Plans to Buy Appliances Index

Commodity Markets Expect Supply Shortages to Abate

Lumber Futures

Corn Futures

Bond Markets Are Expecting “Transitory” Inflation

• The Treasury yield curve has steepened since the beginning of the year, which would suggest that investors anticipate higher growth and inflation in the years ahead.
  • Despite the steepening curve, however, Treasury yields have fallen in recent weeks—even as high inflation measures have been published.
• Treasury markets are currently pricing in moderate inflation over the next 5-10 years.
  • 5-year inflation breakeven:  2.5%
  • 10-year inflation breakeven:  2.4%