A recent Harvard-CAPS-Harris Poll reveals that Americans have concerns about inflation but are increasingly bullish about the economy. Fifty-six percent of respondents believe the economy is strong and their personal finances are improving.

Americans remain concerned about inflation. Prices increased 5% in May, the strongest year-over-year results since 2008. Excluding volatile food and energy costs, prices rose 3.8% from a year earlier.

As a result of bottlenecks and elevated consumer demand, prices have increased for many goods and services such as gasoline, airfares, homes and used cars.

Does our stronger-than-expected price pressures reflect short-term factors or are they representative of long-term factors? Economists and policy makers remain ambivalent about this issue.

The answer about the durability of the inflation has ramifications for both the man on the street and on the investment community. Inflation erodes purchasing power. A temporary burst in prices will not cause lasting damage to purchasing power. On the other hand, if officials at the Federal Reserve believe that we need to prevent on-going inflation, they might reduce their support for the economy. Historically, the Federal Reserve has supported the economy by keeping overnight funds low and purchasing government securities.

For the following reasons, the Fed believes that 12 months hence that inflation will not exceed 2%:

  • Five short-term components are primarily responsible for our recent jump in prices—used cars, rental cars, lodging, airfares, and food away from home.
  • America’s current unemployment rate (5.8%) is still a challenge.
  • In April, the percentage of our (25-54) working population employed was 76.8% compared to 80% before the pandemic.
  • The Atlanta Fed compiled a list of sticky prices (those that did not move often). Sticky prices rose a modest 2.4% over the past 12 months.
  • Globalization has provided cheaper access to supplies and labor.
  • Slowing population growth and aging population has reduced demand.
  • Technology disrupting businesses such as online shopping and virtual conferences have curbed price increases.
  • China, the world’s biggest user of coal, steel, iron ore, and copper, decided in May to curb “unreasonable” increases in prices and thus prevent them from being passed on to the consumer.

Our central bank’s low interest rates have spurred the stock market. Warren Buffett hit the nail on the head when he said, “Interest rates are to the value of assets what gravity is to matter and the rate of short-term Treasuries is really nothing today.” Our current overnight rate is a mere .07%.

In March 2020, the Federal Reserve initiated an aggressive policy of quantitative easing involving the purchase of government securities, corporate bonds, and other financial instruments to keep interest rates low and stimulate the economy. The Fed started purchasing corporate bonds in order to unfreeze the floundering bond market. American companies faced major financial problems because they could not borrow new funds or refinance their current obligations.

For the time being, The Fed will continue to purchase $120 billion of Treasury and mortgage securities monthly. However, starting this month it will sell off its corporate bond holdings.

Currently, the stock and bond markets are signaling the consumer inflation rate, now running at 5%, is transitory.

The S&P 500 recently hit a record intraday high as investors juggled signs of a swift economic recovery with concerns over the Federal Reserve tapering its massive monetary stimulus.

The benchmark 10-year Treasury note’s yield recently fell to 1.47%, down sharply from its May high of 1.74%.

In 1955, William McChesney Martin, the Chairman of the Federal Reserve, said that he was “in the position of the chaperone who ordered the punch bowl removed just when the party was really warming up.”

I am not a party pooper. We can keep our punch bowl but let us fill it with sparkling water!

Originally published in the Sarasota Herald-Tribune