With the U.S. economic recovery now well under way, one of the most pressing questions for investors, business leaders and policymakers has been whether the price surges that have coincided with accelerating activity will pass.
The Federal Reserve has so far maintained that inflation will prove "transitory" and begin to ease as the recovery matures and an initial burst of pent-up demand moderates.
But others are skeptical.
As vaccinations pick up and social distancing standards roll back, consumers have rushed to spend a record amount of savings built up during the pandemic on traveling, dining out, and generally participating in more in-person activities. Many of the accoutrements that accompany rising mobility — from plane tickets to vehicles to food prices to labor in the services sector — have become increasingly pricey as a result. Supply chain bottlenecks have also generated rising prices for producers across industries, many of whom have sought to pass along these increases to end users.
Recent data affirmed what many consumers and producers have anecdotally observed in terms of rising prices. Core consumer prices, excluding food and energy, surged in May by 3.8% from a year ago — the most since 1992 — and producer prices excluding food, energy and trade rocketed by a record 5.3% year-on-year. Core personal consumption expenditures – the Federal Reserve's preferred gauge of underlying inflation — also rose at a near three-decade high in April at 3.1%. For years previously, inflation had undershot the Fed's 2% target.
Those agreeing with the Fed's "transitory" assessment of inflation have largely focused on the fact that many of the biggest categories of goods and services seeing price increases have been those hardest hit by the pandemic. In other words, the sharp plunges in demand last year are now being met with a commensurate resurgence in demand and prices, which may ultimately drift lower as the distance from last year's lockdowns widens.
Already, some categories have given back some advances from earlier this spring, especially in commodities. Lumber futures, for instance, fell below $1,000 per thousand board feet for the first time since late March earlier this week, as noted by Yahoo Finance's Myles Udland, albeit while still holding at more than double last year's prices.
"I would agree with the Fed that this inflation is going to be transitory," Cheryl Smith, Trillium Asset Management economist and portfolio manager, told Yahoo Finance on Monday. "And I'll point to, for example, lumber prices are down 40% since their high in May. Whenever you have a complex economy with things that take longer to produce than three minutes or even three months, you're going to see spikes as an economy restarts."
"When I think transitory, I think the Fed is really thinking in terms of eight months, nine months, a year. It'll take that long for supply chains to start getting back into shape," she added. "So I think that the Fed is being very appropriate on that wait-and-see."
Others took a similar view. According to Bank of America's June Global Fund Manager Survey, 72% of those surveyed said they believed inflation would be transitory, compared to 23% who said inflation would be permanent.
"I'm on team transitory, and I think most of the Fed governors are still there," Joshua Lipsky, Atlantic Council GeoEconomics Center director, told Yahoo Finance on Tuesday. “The Fed’s been extraordinarily successful in their narrative—they’ve been consistent.”
However, others think inflation will prove longer-lasting than some policymakers have acknowledged.
"The continued surge in prices last month was again mostly concentrated in sectors reopening or facing intense supply constraints, which allows the Fed to stick with its 'largely transitory' story for now," Michael Pearce, senior U.S. economist for Capital Economics, wrote in a note published on June 11. "But with signs of cyclical price pressures building and the extremely strong job openings and quits figures pointing to stronger wage pressures, we believe the Fed will eventually have to acknowledge that inflation will remain elevated for much longer."
A number of business leaders also maintained that structurally higher inflation may be here to stay.
"It's not just the fact that commodity costs are inflating, but it's the pace of that inflation," Clorox (CLX) Chief Financial Officer (CFO) Kevin Johnson said during Deutsche Bank's Global Consumer Conference on June 9. "We've seen a tremendous ramp-up that really started at the beginning of this calendar year. Our view is this is not transitory. And so we're planning as if we're going to be operating in this environment for the better part of our fiscal '22."
"If you think about the backdrop that's created ... you look at the latest GDP forecast showing the U.S. growing somewhere high single digits, low double digits — that hasn't happened in decades," he added. "And then you also look at pretty high government spending. When you put that mix together, that suggests to me that this is not a temporary issue we're going to get through in the next three to four months, but it's longer-term."
3M (MMM) CFO Monish Patolawala similarly noted that the manufacturing conglomerate was "seeing inflation on all sides," from raw material to labor and logistics, according to remarks at UBS's Global Industrials and Transportation Conference earlier this month. And during a company conference presentation, Stanley Black & Decker (SWK) executives also said they're now assuming the inflation they're seeing will continue at least into next year.
"The demand has not abated and the price increases are sticking," Stanley Black & Decker CEO James Loree said during a UBS conference presentation earlier this month. "We held off on that for a period of time because we weren't sure whether the inflation was transitory, and we didn't want to put our market share and our customers in a place where we all didn't want to be."
"But at this point, we've said that inflation is big enough and is pervasive enough in the market," he added.
Adding to these concerns are data showing that consumers' expectations for higher inflation are mounting. The Federal Reserve Bank of New York's May Survey of Consumer Expectations showed household expectations for inflation next year rose for a seventh straight month to a record high. And likewise, the University of Michigan's preliminary June sentiment survey showed inflation expectations for next year and the next five years were still elevated compared to prior months.
'Somewhere in the middle'
Others have taken a more middle-ground approach, arguing that it may take more time to ascertain whether price increases do stick. And others noted that price increases could prove more permanent in some categories while ultimately petering out in others.
"I'm going to say I stand somewhere in the middle, but on the side of the Fed is risking getting this wrong," Steve Sosnick, Interactive Brokers chief strategist, told Yahoo Finance. "I think the labor costs tend to be a bit stickier. Commodities go up and down."
"I think that's why you're seeing employers go with signing bonuses or other non-salary type of incentives to get people in," he added. "Because if you give someone a $500 or $1,000 signing bonus, they don't expect another one of those. If you raise salaries by a couple of dollars an hour, that's a sticky cost."
According to the Labor Department's May jobs report, average hourly earnings spiked by a greater-than-anticipated 2% in May over last year, and by 0.5% in May over the prior month. Some economists attributed this in part to fewer lower-wage service sector employees reentering the workforce than in prior months. But others suggested the jump also reflects actual wage increases as employers compete to fill open positions. These wage hikes could in many cases outlast the post-pandemic recovery.
"The inflation picture seems to be divided into two areas," Omar Aguilar, Charles Schwab chief investment officer of passive equity and multi-asset strategies, told Yahoo Finance on Tuesday. “One is really more related to the supply and demand imbalances … That is mostly driven by supply chain disruptions that happened during the pandemic period as well as significant increases in commodities. Those historically tend to be heavily transitory. As supply and demand start to meet into one place, all of a sudden the price pressures start to go to a normal level."
“The other part [is] related to the labor market and labor growth and the cost of labor,” he added. “And that seems to also be bifurcated into two areas — the service sector and the manufacturing sector. In the manufacturing sector clearly the labor cost is something that is a little easier to adjust with price power … However, in the service sector, which is where we saw the biggest decrease in labor costs prior to 2020, that’s where we actually see those wage growth pressures, and that’s the area that could not be transitory.”
Emily McCormick is a reporter for Yahoo Finance. Follow her on Twitter: @emily_mcck
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