Jill On Money: Agitation over inflation

As economists and analysts are lauding efforts to help low to middle income consumers, they are keeping a watchful eye on prices.

The American Rescue Plan is now law, which means that to combat a once in a century pandemic — one that has claimed more than a half a million American lives, the U.S. government will have pumped more than $5 trillion into the $21 trillion economy over the course of 12 months. For all of the benefits of pushing money into the wallets of households and businesses, what could be the

downside of the spending?

Glad you asked. As economists and analysts are lauding efforts to help low to middle income consumers, they are keeping a watchful eye on prices. After all, it stands to reason that prices will rise from last year’s abnormally low levels, once the economy reopens and people spend their rescue money and/or savings that they have accumulated.

Inflationary fears have come and gone over the past decade, but overall, sustained higher prices have not materialized. In fact, inflation is below where it was for much of the 2000s, prior to the financial crisis. The Consumer Price Index (CPI) was up 1.7% from a March a year ago. While that’s low, it marks an acceleration from the previous month. Concurrently, inflation expectations are increasing, and like many aspects of the economy and the financial world, expectations can drive the narrative more than the numbers, at least in the short-term.

Consumers are sensing a sea change in prices, according to the New York Fed’s latest survey. Inflation is expected to increase above 2% over a one-year and three-year time horizon (that has not happened since 2014), and investors’ actions in the bond market indicate similar concerns. (When inflation rises, it is not good for bonds, because the fixed interest that you earn buys you less. That’s why the bond market has been dropping lately.)

Expectations can be self-fulfilling because if you are worried that you will be paying more for housing, gas, groceries and utilities, you may ask for higher wages. That in turn might cause businesses to charge more for goods and services, which could change inflation dynamics. Officials are brushing aside these worries. Federal Reserve chair Jerome Powell said he didn’t expect prices to increase to the point “where they would move inflation expectations materially above 2%.” When asked about whether trillions of dollars of government spending would spark inflation, Treasury Secretary Janet Yellen said, “I really don’t think that’s going to happen.”

Mark Spindel, the Chief Investment Officer of the District of Columbia Retirement Board (and a childhood friend of mine) explained why Powell and Yellen do not seem worried. Sure, inflation will rise, but that’s “mostly as a result of very depressed numbers from the pandemic onset last year.” Spindel projects that “in the medium term, inflation will settle back around 2% as it has been for most of the past generation.”

Diane Swonk, Chief Economist at Grant Thornton adds “much of the rest of the world is still fighting decelerating instead of accelerating inflation. This will act as another offset to inflation in the U.S., despite recent weakness in the dollar.” If inflation does rise, Yellen says that the Fed has “tools to deal with that,” though some of those tools have not yet been tested, which is causing some of the agitation in the fixed income markets lately.

I have heard from some who are ready to throw in the towel on their bond positions, due to inflation expectations. Not so fast. Spindel advises investors “to think about their portfolios in a long-run, balanced way. If we are right that inflation remains reasonably well behaved, I think bond allocations can provide some needed diversification,” even if rates remain relatively low going forward.

Jill Schlesinger, CFP, is a CBS News business analyst. A former options trader and CIO of an investment advisory firm, she welcomes comments and questions at askjill@jillonmoney.com. Check her website at www.jillonmoney.com.