How high could inflation rise?


Russell Price, Chief Economist – Ameriprise Financial

 

Key Points

  • Inflation could rise over the next few months to multi-decade highs but is expected to be temporary.
  • The uncertainty could cause some market volatility over the intermediate term.
  • Certain consumer goods and services could see notable price increases as business restrictions ease, demand rises and availability remains tight.

Consumer spending is likely to surge in the months ahead — and for good reasons.

  • More people are receiving the COVID-19 vaccine.
  • Business restrictions are slowly being lifted.
  • There is greater confidence to safely venture out.

Recent employment gains and federal stimulus payments have also provided consumers with ample financial resources to spend, in our view. Many are understandably eager to resume the social aspects of life after enduring the last 14 months. Thus, interest in vacations, entertainment or simply an evening at a nice restaurant has been rising fast.

Conditions are ripe, however, for any surge in demand to be met with limited availability and higher prices. For example:

  • Many restaurants went out of business during the downturn. Those that survived did so with significantly less staff. At a minimum, we believe it will take many months for restaurants and other venues to reattain their prior capabilities.
  • Most of the nation’s major airlines have announced plans to significantly rebuild capacity for the months ahead. Over the intermediate term, however, airline seat availability may not rebound as quickly as demand.

Further, prices for certain goods are higher as global supply chains struggle to recapture their pre-pandemic efficiency. For example, a global shortage of semiconductors is limiting production for most major automakers. The recent obstruction of the Suez Canal also backed up some supply chains.

 

The trajectory of inflation

We believe inflation is likely to peak in May. Specifically, price levels then will be compared against the depressed price levels of a year-ago when much of the economy was shut down. This simple comparison alone could add a full percentage point to the Consumer Price Index (CPI), in our view.

However, the boost from weak comparisons should fade quickly. We currently forecast the CPI to end 2021 at a rate of +3.0% after peaking at an estimated +3.7% in May. Importantly, Federal Reserve officials have indicated their intention to maintain stimulative policy until the economy returns to full employment.

It’s been a long time since inflation was a legitimate economic concern. For that reason, financial markets may experience periods of higher volatility until inflation pressures ease. Historically, during inflationary periods some market segments such as Materials, Financials, precious metals and Treasury inflation-protected securities (TIPS) have outperformed broader market measures. These same segments typically do well during early economic expansion periods, but they already have appreciated materially.

If the period of stronger price increases is temporary as many expect, traditional “inflation hedges” may have already seen their strongest gains. Additionally, we believe investors with broad equity market exposure are likely in a good position to capture any benefit these sectors may experience without the added risk of trying to time the market.

 

Summary

Over the next several months, inflation rates could rise to levels not seen in many years. The higher rates, however, are widely expected to be transitory and could be relatively well tolerated across financial markets.

Any period of elevated inflation, however, adds a level of uncertainty to the economic path forward. We believe most investors are best served in these periods with personalized financial advice and a well-diversified portfolio tailored to their individual goals, needs and risk tolerances.