April 23, 2021
The Fed claims that we are seeing a temporary runup in inflation which will eventually dissipate and settle in at a pace slightly above its 2.0% target. Perhaps. But our fear is that we could see a sustained increase in inflation in excess of what the Fed envisions. Right now the housing sector is on fire with double-digit gains in house prices and they are accelerating. Builders cannot find an adequate number of skilled workers. The food and beverage industry is trying to scale up production but owners cannot find enough cooks and servers. Firms are bidding up wages in an effort to attract an adequate number of workers. Gas prices have climbed to almost $3.00 per gallon. Commodity prices are surging. Supply shortages are evident throughout the manufacturing and service sectors at the same time that consumers are inundated with cash. That is not a recipe for some temporary blip in the inflation rate. It seems to us that the inflation risk is all on the high side.
Home prices are surging. In the past year prices have risen 11.2%. But in the past six months they have accelerated to 17.0%. Why? Because the demand for housing has skyrocketed. Fueled by fat stimulus checks consumers have money to spend. Mortgage rates remain extremely low at 3.1%. With many people now able to work from home, renters are fleeing the big cities for cheaper alternatives in more affordable suburbs.
As home sales have accelerated the supply of homes available for sale is not even close to what is needed. At a minuscule 2.1 months the supply of homes is about one-third of what is required to bring supply and demand into balance. Further, the typical home sits on the market for just 18 days — the shortest period of time ever between listing and sale.
This housing imbalance will continue until such time as builders are able to significantly step up the pace of production. They are trying, but every builder is challenged to find enough bodies. Their costs have escalated as surging lumber prices have tacked on an additional $26,000 to the price of a new home. Local building restrictions have curtailed the supply of lots available to builders in an effort to moderate the rate of growth in those suburban communities. Supply is unlikely to catch up with demand any time soon.
Potential home buyers will eventually recalculate the tradeoff between buying a home versus renting and conclude that homes have gotten too expensive and decide to rent instead. At that point, rents will begin to climb which is a big deal because the “shelter” component represents one-third of the entire CPI. Currently, shelter prices have moderated because of rent forgiveness for renters who lost their jobs during the pandemic. But at some point rent forgiveness will end. When it does a large portion of the CPI will begin to accelerate.
Gas prices have now climbed to almost $3.00 per gallon. Prior to the recession gas prices were $2.50. Thus, prices are now higher than they were prior to the recession. Given that the recovery is gathering momentum, not just in the U.S. but around the world., which way do you think gasoline prices are going from here?
Government restrictions last year shut down the economy and supply chains were disrupted. Firms cannot simply flip a switch and restore the flow of necessary inputs. The supplier delivery component of the Institute of Supply Managers monthly survey indicates clearly that the flow of materials from suppliers has been significantly curtailed. Every firm is struggling to find a solution.
Once these firms re-establish their supply chains, they will still be faced with higher prices of virtually everything. Oil prices have risen. Prices of non-energy commodities has been surging as well and are now at their highest prices in the past eight years. The price increases are broad-based with copper, lead, aluminum, zinc, steel and lumber leading the way.
The government shut down the economy in the spring of last year. It then flooded consumers with cash in the form of a series of stimulus checks. Demand has surged, but supply chain disruptions have emerged. Firms are scrambling to find enough workers and materials to boost production. You might think that with the unemployment rate at 6.0% firms would easily be able to find enough bodies to hire. They can’t. Job openings are back to where they were prior to the pandemic but hiring is lagging. With $300 of Federal unemployment benefits continuing through September 6 in addition to state benefits, many unemployed workers seem content to remain on the sidelines and live off government provided benefits until they expire.
Powell may think that this increase in inflation is temporary; we are unconvinced. The reality is that 27% growth in the money supply is unprecedented. We saw 15% money growth back in the late 1970’s at which time the inflation rate was also about 15% . Powell says that we have to unlearn that connection between growth in the money supply and the inflation rate. We are not yet prepared to do so. Time will tell which view is correct but everything we can see suggests that the risk is on the side of an increase in the inflation rate in excess of the 2.0-2.5% pace the Fed deems acceptable.