Firms and consumers are worried about inflation due to the unprecedented increase in the money supply over the last year. The Federal Reserve and most Biden administration officials are attempting to assuage fears of runaway inflation by referring to the increases we’re seeing now as “transitory,” which in their mind means “don’t worry.”
But “transitory” inflation could mean one of three scenarios:
- Prices rise and plunge
- Prices rise and stay where they are
- Prices rise and continue to rise, but more slowly
A sharp and permanent increase in home prices and costs is certainly worth worrying about, as is a sharp increase followed by a decline in value. Inflation fears incentivize consumers to lock in payments sooner rather than later, especially if they’re confident they can stay and make payments long-term.
Team Transitory: Temporary Inflation Due to Demand and Supply Shocks Will Work Itself Out
We think the Fed and other members of “Team Transitory” are correct in that some of the drivers of high headline inflation prints over the last several months will resolve themselves over the short- to medium-term (6–18 months).
COVID and associated stimulus has created two simultaneous shocks to supply and demand for goods in particular:
COVID-related restrictions made goods more difficult to manufacture and transport, and the resulting supply shortages for goods have allowed manufacturers to raise prices. However, supply will eventually catch up with demand as restrictions are eased and manufacturers ramp up to full production.
- Lumber futures, for example, have fallen considerably and have wiped out their 2021 gains.
- “The supply side [in some sectors] was caught a little flat footed” – Fed Chair Powell
Three rounds of government stimulus worth $5 trillion have padded consumer bank accounts, and extra savings have juiced demand (and therefore prices) for goods and services across the economy. Demand will eventually subside as savings are spent.
- $2.5 trillion in excess savings for consumers is primed to be spent this year and next.
- Capital expenditures dipped during COVID but peaked in 1Q21, which will slow 2022 inflation.
Team Persistent: Prepare for Some Permanent Inflation Due to Long-Term Trends
Consumers, businesses, and other members of “Team Persistent” that are baking inflation expectations into today’s decisions support the notion of permanent price increases.
- In fact, we polled 210 clients last month and 70% believe recent rampant price appreciation will not result in a fall from today’s prices over the next 5 years.
- Additionally, we expect wages to increase as the supply of workers dwindles due to heavy retirement.
Labor will be undersupplied for a very long time due to low immigration and an uptick in retirees. This will put upward pressure on wages, which will increase the cost of goods permanently.
- Working-age population growth is low and will remain low for the next several years.
- Hourly wage data is artificially low due to a higher share of wage increases in low-wage sectors.
A flood of money into the economy has created buying power that will last years. Consumers and businesses alike are also expecting inflation, which will allow for price increases.
- Banks have $3.9T in reserves (2x pre-COVID) and the velocity of money is at an all-time low; money must be spent to show up as inflation, and we have not yet felt the full impact on prices.
- Consumers expect double-digit increases in several commodities over the next year, including rent, gas, and medical care.
- Businesses are increasing their 5–10-year price increase expectations, per the Atlanta Fed.
Expect Rising Costs and Revenues Due to Inflation
Demand and supply will eventually meet each other, meaning that inflation will technically be transitory. However, don’t be fooled by this soothing word. Substantial wage increases are already occurring, which will raise the cost of many goods permanently.
Plan on the following until the next recession hits:
- Declining material costs: commodity prices that are less dependent on labor will eventually fall as supply catches up with demand.
- Rising labor costs: prices for goods that are labor intensive will likely increase and remain high until the next recession.
- Rising revenues: some rent and home price increases will be permanent since home buyers will have more money, but that doesn’t mean home prices can go to the moon.
- Questionable land price: while land is a commodity, residential home prices are a function of the following formula:
estimated future revenue – estimated future costs – normal profit margin = land value
With revenues likely to increase in areas where they haven’t grown too much already, and costs likely to decrease, land values should do well in most areas.