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Inflation: Transient or Here to Stay?

S Rossi 2014
Stephen A. Rossi, MBA, CFA®, CFP®, ChFC®
Senior Vice President, Senior Equity Strategist
[email protected]
(585) 419-0670 x50677

Published on August 10, 2021 in the Rochester Business Journal

Inflation seems to be top of mind lately, garnering the attention of economists, political pundits, business owners and laymen alike – but what exactly is inflation, how is it measured, what’s considered to be normal, and how high is it now? Also, what’s been causing prices to rise, how does the Federal Reserve Bank feel about recent inflationary trends, and what’s the bond market suggesting about the short-term or long-term nature of these trends?

Investopedia loosely defines inflation as a decline in the purchasing power of a given currency over time, as reflected in an increase in the average price level of a basket of selected goods and services. Essentially, it’s when things become more expensive or, all else equal, when a currency like the U.S. dollar buys less.

The two most popular measures of inflation are the Consumer Price Index (CPI) and the Personal Consumption Expenditure (PCE) index. According to the Cleveland Federal Reserve Bank, the CPI measures the change in price (over time) of a basket of goods and services, based on a survey of what households are buying, while the PCE measures the same change in price, based on a survey of what businesses are actually selling. Even though the Federal Reserve Bank’s preferred measure of inflation is the PCE index, the more commonly followed measure of inflation is the CPI.

According to, average annual inflation as measured by the CPI was 3.5% per year from 1979 through 2020. However, over the last 21-year period ending 12/31/20, average annual inflation has been closer to 2.1%; over the last 13-year period, it’s been closer to 1.7%. Indeed, if an average inflation rate of about 2.0% is considered normal, it’s easy to see why there have been some furled eyebrows this year, as the most recent CPI reading for June reflected an annualized inflation rate of 5.4%. According to the U.S. Bureau of Labor Statistics, trailing twelve-month price increases in used cars and trucks (up 45.2%), gasoline (up 45.1%), fuel oil (up 44.5%), utility gas service (up 15.6%) and transportation services (up 10.4%) were the biggest contributors to this statistic.

In terms of what’s causing the recent spike in inflation, let’s consider that prices are being measured from a year ago when we were still in the midst of a pandemic, and when prices/demand had declined considerably. As we’ve progressed through a recovery since then and as is typically the case coming out of a recession, demand exceeds supply in the near term, as businesses race to bring capacity back online, and prices begin to rise. Not only do consumers have a desire to spend, after being largely confined to their homes for much of the last 16 months, but they, partially thanks to recent Government stimulus checks, have the wherewithal to spend as well. Again, combine forces contributing to higher demand with labor shortages and other supply constraints in certain industries and presto…higher prices.

The Federal Reserve Bank (Fed) doesn’t seem to be particularly concerned about recent price increases, suggesting that much of the activity will be transient, as supply catches up to demand, and as we return to a more stable level of unemployment. With inflation running so low for so long in our most recent past, the Fed has even relaxed its stance on short-term inflation, now aiming for a 2% average rate of inflation as opposed to a specific 2% target rate of inflation. The implication is that, even if recent price increases prove not to be so transient, the Fed is willing to let inflation run hotter than 2% for some period of time, so long as 2% long-term average rate of inflation is maintained.

Judging from recent activity in the U.S. Treasury market, the Fed’s speculation on the transient nature of short-term inflation may be correct. When we look at how a 10-year U.S. Treasury Note is priced versus a 10-year Inflation-Protected Treasury Note (aka TIP, or Treasury Inflation-Protected Security), we find that investors’ collective expectation for inflation over the next 10-year period is approximately 2.3% per annum as of 7/16/21. This would support the Fed’s intent to continue holding its short-term lending rate near zero until at least 2023, provided that the Fed and investors in general have it right.

Whether the Fed and investors have it right or wrong as far as its short to intermediate term inflation expectations go, let’s remember three things: one, it’s unexpected inflation that tends to cause the greatest gyrations in financial markets; two, the Fed is typically late to the party when it comes to raising interest rates to head off inflation - often going too far, too fast and throwing us into another recession with their catch-up style of interest rate increases; and, three, that inflationary tailwinds may continue to build over the next ten years, with the impending funding needs of the Medicare, Social Security Disability, and Social Security Income programs, especially if we print more money to meet these needs as opposed to borrowing it instead. Transient or here to stay? Suffice it to say that when it comes to longer-term inflation expectations, there’s enough uncertainty on the horizon to keep everyone guessing.

To see this column in the RBJ, click here.

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