By Tim Courtney, Chief Investment Officer
As we all painfully know, inflation has been causing major economic issues since 2021. Since we’re all paying more attention to inflation now, news reports are making more references to the various ways of measuring it. Overall inflation is typically based on the Consumer Price Index (CPI),1 which tracks what American consumers are paying for a wide variety of goods and services. The CPI registered 6.4% year-over-year for January.2
Within this index, another measure called Core CPI (5.6% year-over-year in January2) excludes the volatile food and energy categories. On top of this, a newly fashionable measure called Supercore CPI looks specifically at the price of core services excluding housing, and Federal Reserve Chair Jerome Powell recently stated that it was running at about 4%.2 With so many measures to reference it is starting to get comical, and we are half expecting to soon be reading about the level of Double Secret SuperCore CPI inflation.
The bottom line is that however you want to measure inflation, the measures have been declining but remain uncomfortably high. Many changing inputs and government policies over the last couple of years led to distortions that are roiling through labor, goods and services markets. Supply and labor shortages have forced consumers to decide whether they want to buy preferred goods and services at elevated prices, substitute cheaper alternatives or abstain entirely.
The natural effect when prices spike is for demand to eventually subside as consumers can no longer keep up with the increases. So far, spending doesn’t appear to have fallen by much if at all. Another effect is for supply to increase when prices are high, and some of this has happened as supply chains have been fixed.
So even though we think it is likely that inflation will continue to decelerate, it could stay elevated at levels because of continued labor shortages, continued elevated demand and de-globalization. This may surprise markets which have to date critically misjudged how severe inflation would become, both in level and longevity. Even now, market expectations for inflation over the next decade are very low — about 2.5%.3 Expectations for the next three years are not too far from that even though the most recent reading was 6.4%.
The market seems to be demonstrating recency bias, where participants are estimating that inflation will settle right back into the range where it remained for so many years. We went through a fifteen year period from 2006 to 2020 where inflation averaged an extremely low 1.9%.4 After such an extended run of consistently good conditions, it’s not surprising so many expect us to soon be back experiencing the good times. But this may not happen, and inflation could be settling in closer to its long term average of 3% or higher for at least a time.
That’s a risk investors should be aware of even though the market is discounting it. At Exencial, we carefully consider inflation’s potential path when crafting our investment models and strategy. We believe inflation will continue to fall from current levels but most likely settle into a range of 3% to 5% for a time. Please contact your Exencial advisor with any questions.
- U.S. Bureau of Labor Statistics (2/24/23) — Consumer Price Index
- The Wall Street Journal (2/14/23) — Inflation is falling, and where it lands depends on these three things
- Federal Reserve Bank of St. Louis (2/24/23) — 10-year breakeven inflation rate
- DFA Returns 2.0 – US CPI Inflation 01/01/2006 – 12/31/2020
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