In general terms, If inflation reaches 3%, the Federal Reserve
may have to accelerate its timetable for raising interest rates.
Bond yields will rise to compensate investors for the loss in
purchasing power. Mortgage rates will tick higher. The present
discounted value of all dividend and corporate earnings will be
trimmed, and the stock market to the degree that it is partly
rational will experience some level of correction. Inflation as
measured by the Consumer Price Index has been lying dormant for the
past five years, averaging only 1.3% per annum. Modest price
pressure arose last year, however, and the most recent CPI
inflation in February advanced by 2.1%. The following are the
conditions which makes it ok to assume the market prediction for
inflation is the best guess-
- The unemployment rate is low, and will trend even lower.
Economic textbooks say that once employment is full with the
unemployment rate at around 5% or so, then any further tightening
in the labor market will put upward pressure on wages and
consequently on prices. In February, the unemployment rate was
4.1%. There is no recession on the horizon. Unemployment insurance
filing is at historic lows, and the number of job openings is at
historic highs. The unemployment rate will surely head lower.
- America is swimming in high levels of wealth. The boom in the
stock market, combined with steadily rising home prices, boosted
the combined net worth of all households to a record high of $98.7
trillion at the end of 2017. To be sure, wealth distribution has
become unequal, but anyone with some exposure to the stock market
and to real estate has improved financially. Real estate net worth
(home value minus amount of mortgage owed) held by households
reached $14.4 trillion, an all-time high and more than double from
the recent cyclical low point in 2010. High wealth means more
confident consumer spending and consequently added pressure on
retail prices. Even if there is a 10% correction in value, the net
worth is still way up there.
- Oil prices will not collapse. Energy and gasoline prices have
been rising at a near double-digit pace in recent months and at a
minimum we will not see a price decline in that sector. The U.S.
economy is in no danger of a recession, but this is also the case
with many countries across the globe. The strengthening global
economy will require greater energy usage.
- Rents and home prices will continue to move ahead at a good
clip. There is a shortage of housing in America due to significant
underproduction of new homes over the past decade. In normal times,
around 15 to 17 million new housing units would be built over a
decade to accommodate rising population and to replace obsolete
units. In the last 10 years, only 8.8 million new homes were built.
This shortage cannot be fixed quickly. That means rents and home
prices will easily continue to rise by at least 3%, as has been the
case over the past five years (technically, home prices are not
part of the Consumer Price Index, as homes also represent a
financial investment. What is included is something called a
“homeowners’ rent equivalence” that attempts to measure what a
homeowner would pay in rent for their home).
Many other factors can move inflation one way or the other. For
example, trade restrictions may mean higher prices for toys and
shoes. Plenty of rain and good harvests can keep food prices
manageable, while a drought can do the reverse. Distribution
efficiencies by online retailers like Amazon could hold prices
down. A shortage of truck drivers could boost the cost of
transportation. More people seeking work after having been out of
the labor force will boost labor supply and hold wages from
accelerating too fast.