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Central banks have a notoriously bad track record when it comes to predicting the rate of inflation. The models used to measure it conveniently indicate it’s nonexistent. But the price of commodities, real estate, food, and more prove that inflation is here.
Despite the rising cost of living, current forecasts suggest inflation won’t be a problem anytime soon. Regardless of central banks’ relaxed outlook, investors are still worried that inflation may get out of control.
Why Inflation Concerns Are on the Rise
Large-scale pandemic stimulus packages have ballooned the money supply, and once the economy reopens, the velocity of money could pick up. In simpler terms, there will be more money chasing a limited amount of goods, causing prices to increase.
Americans have been hoarding cash, the money printer is on full blast, and supply chains have been crippled from the pandemic. It all sounds like a perfect storm is brewing for a strong inflationary environment. For this to happen, the economy needs to be running hot, and money needs to move out of savings accounts.
COVID vaccines and getting back to normal mixed with pent up demand could spike the price of goods. How much prices will rise and how long the rise will continue is difficult to tell.
The US still isn’t even fully reopened yet, and the recovery could take much longer than most expect.
Consumers spend more when they are confident in their financial stability. And confidence will remain low until unemployment gets under control.
Rising Treasury Yields and the Market
As inflation expectations rise, bonds become less desirable, causing investors to sell them. Selling bonds pushes the price down and increases the yield. The 10-year Treasury yield jumped above 1.50% last week, causing a selloff in equities.
Why? Well, owning a treasury bond is essentially risk-free. If institutions can get a risk-free return that is as good or better than the dividend yield of the S&P 500, the risk of owning stocks is no longer necessary. Money flows out of stocks and into bonds because the yield is now more desirable.
Investors have always watched treasury yields and the yield curve to forecast an upcoming recession or point to a risk-on environment.
What History Has Taught Us About Inflation
Inflating away huge government deficits and decreasing the purchasing power of fiat currency is standard central bank procedure. These actions widen the wealth inequality gap and lower the cost of the national debt. When governments finance their spending by printing more money, inflation is almost always inevitable.
Zimbabwe and the Weimar Republic are historical examples of hyperinflation crumbling a financial system. In both cases, hyperinflation was mainly triggered by the abuse of money creation. The other trigger is poor economic stability.
If there is an extreme increase of money supply in a country with diminishing economic productivity, it could likely result in financial collapse.
The United States has always been known as an economic powerhouse, and the US dollar is the world reserve currency. So, comparing the US to the likes of Zimbabwe and the Weimar Republic isn’t the best way to forecast our economic future.
Deflation Is Still a Possibility
Japan is a better example of what could happen in the US. Japan’s economy has struggled to grow for decades, inflation hasn’t picked up, the national debt is sky high, and interest rates are negative.
A severe recession usually leads to deflation, and all of these stimulus checks have been tools to fight against it. The stimulus and money printing may not be enough to ward off deflation.
Asset prices are in a massive bubble, and a deflationary spiral could pop it.
Hyperinflation seems unlikely despite all the media pumping out inflation fears. The economy needs a strong labor market to really spark inflation and unemployment is still significantly high.
February 2021 US Market Performance
February 2021 Market News Highlights
A global chip supply shortage is impacting several industries. Automakers and more have been forced to stop the production of specific goods. The lack of semiconductors is expected to continue throughout the rest of 2021. To address the issue, president Biden signed an executive order to start a 100-day review of the semiconductor supply chain.
Meme stonks live on. Game Stop, AMC, Koss, and more all erased much of their gains from the initial short squeeze mania but have begun to spike again. Redditors are still chanting diamonds hands while they continue to hold heavy bags of unprofitable meme stocks.
Coinbase will soon be a publicly-traded company. The cryptocurrency broker is preparing to become a publicly-traded company through a direct listing (DPO). The exact date is still unknown, but the ticker symbol will be COIN. Estimates suggest the valuation could top $100 billion.
Moar Stimulus. The bloated 1.9 trillion dollar coronavirus relief plan is still in the works but close to being finalized. The bill has passed the house and will likely pass the Democratic-controlled senate. The $15 hourly min wage increase is unlikely to pass. But if the bill gets approved by March 12th, stimulus checks should arrive around the end of the month/beginning of April.
The Berkshire annual letter shows that Warren Buffet is still hoarding cash. The company’s cash reserves dropped a bit but are still over $138 billion. Buffett announced Berkshire Hathaway would continue to buy back more shares keeping pace with the large-scale share buybacks done in 2020. Buffett shied away from saying anything regarding the coronavirus or politics but pointed out the resilience of the American economy.
US Economic Indicators Recap
Total Vehicle Sales increased to 16.6 million in January, reaching its highest level since its April 2020 lows.
US National Debt is nearing $28 trillion, and the current debt to GDRP ratio is 129.56%.
Core Inflation Rate increased by 1.4% year-over-year in January, missing market expectations of 1.5%.
PPI producer prices increased 1.7% year-over-year in January, beating market expectations of a .9% increase.
Consumer Confidence rose in February to 91.3, beating the forecasted reading of 89.7.
Housing Starts dropped 6% month-over-month to 1580 thousand in January from a near 14-year high of 1680 thousand in December. The reading significantly missed the market forecast of 1658 thousand.
The Federal Reserve chairman Jerome Powell testified to lawmakers last week, stating the central bank would continue its dovish path while the economy recovers. Powell admitted a link to rising asset prices and the Fed’s policies but said many other factors were contributing as well.