Inflation, just how bad is it?
It seems that just about every headline in every media outlet is talking about inflation and there’s as many opinions about inflation as there are headlines. So, I thought I’d go through a quick summary of the various components of inflation with the idea of maybe improving our general understanding.
We have this headline number of inflation. The most recent headline was *8.3%, which was slightly lower than the month before, but inflation is made up of bits. We’ve got fuel, we’ve got food, we’ve got housing, we’ve got pretty much everything else. We’ve got core inflation, which includes housing and everything else and we’ve got the fuel and food inflation. So this gets a little fun. Oil, as we know is $120 a barrel, a little bit over. The average price of a gallon of gasoline throughout the country is $5. Historically, that’s not that terrible, but we’re not used to normal priced fuel. We’ve been getting low-priced gas for many years now.
Food is really a story about staples and of course, staples are being hurt very much by the breadbasket of Europe being in the middle of this little war with the Russians. Food prices are really hurting those who are at the lower end of the economic rungs. Interestingly enough, inflation is lower the more expensive the food becomes. The kind of food that you get at Whole Foods has not gone up as much as the foods you might get at Walmart.
Housing is an interesting part. See, core inflation is just 6.2% when you strip out fuel and food. The reason they do that is because fuel and food are volatile components. In fact, one of my favorite quotes is the cure for high prices is high prices and that is very true with fuel. Sooner or later, this is coming back down. On the food side, it is going to take a little bit longer. We’re going to have to develop new food sources. There must be stabilization in the Ukraine. It looks like an entire harvest has been lost. So, we don’t expect that to improve much between now and this time next year.
Everything else is affected by the supply chain and what’s good news about the supply chain is the biggest component of our supply chain is China. China was being hurt by the lockdowns. Another major component are tariffs, and there’s beginning to be a little bit of “nod nod, wink wink” let’s back off on some of these tariffs. Because they significantly hurt inflation.
The wild card is the housing market. The housing market, the way it feeds into an inflation statistic is through rents and there’s a bit of a time lag. Rents have not kept up with property values. Property values have gone up, on average, in the United States in the last two years an aggregate of 50%. Different markets are different, but when those rents start catching up and it’s not likely they’ll catch up completely because the odds are there’s a balloon going on, a bubble out there. Assuming that bubble pops a little bit, rents still have lots of room to grow. So, core inflation could be better or it could be worse and only time will tell.
So what’s next? Well either we’re going to get a slowdown, a soft landing engineered by the Fed, or we’re going to get a full board recession. Obviously everybody wants the first and there’s a lot that’s going on to encourage that outcome. I mean, quantitative easing is now in mild reverse. Interest rates are getting hiked. The problem is if they overshoot, if we go into a full blown recession, if their bubble bursts, we’re going to have a real slowdown.
Now, that will help inflation because what happens in a recession? Labor demand falls and one of the inputs that’s significantly impacting inflation today is the cost of labor. So, there are early signs that there are dampening inputs to inflation. In fact, the expectation for this month’s core inflation is about **5.9%. Yet, ironically, we may see a headline inflation peak at 10% before we see these numbers come down.
So, it’s too early to call the peak but what we’re seeing here, I’m not going to use the word transitory, but it’s to be determined over the next year just where inflation will level off. The odds are at least even it’ll be at some point lower than where it is today. What can you do about this is? Not a lot, be careful with those fixed income products and at least take heart and the knowledge that, to the extent you have debt, it’s getting monetized at almost 10% a year. We wish you the best of investing success.
Notes:
*Since the time of recording the latest inflation numbers show a slight increase to 8.6%.
**Core inflation has increased to 6%, up from the 5.9% estimate.