Michaela A. from St. George, UT asks: Hi Mitch, I’ve been hearing and reading so many different takes on inflation. The Federal Reserve says it’s “transitory,” but everyone else seems to think it’s a huge deal. I’m trying to make heads or tails of it. What are your thoughts?
Mitch’s Response:
Thanks for your candid question, Michaela. I’ll return the favor and get right to the point.
The inflation question, in my view, should not be framed as whether the U.S. economy will experience inflation in 2021 and beyond. Inflation is already here.
The question is whether inflation will be short-term—as in, an issue for the next few quarters—or whether inflation will become a persistent, longer-term issue, which would necessitate drastic monetary tightening from the Federal Reserve. I think the answer is probably somewhere in between.
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People often forget, but the 10-year U.S. Treasury bond is arguably one of the best tools for forecasting inflation. If the 10-year U.S. Treasury bond yield rises persistently and substantially, it is usually a sign that the market is expecting higher inflation in the future. After all, investors who expect higher inflation in the future will demand a higher yield on fixed income today. As you can see in the chart of the 10-year U.S. Treasury bond yield, rates have moved higher in 2021, but not alarmingly so. Rates are still very low historically.
As for the Federal Reserve, there is another way forward when it comes to keeping inflation under control: slowly and methodically start to tighten monetary policy. In my view, current fears in the market are that the Fed will be forced to take drastic measures to rein in inflation, but I do not think the outcome will be quite so dramatic. In the most recent Fed minutes, for example, most of the committee’s language seemed to indicate that inflation was being watched closely, but that the risk was balanced with the prospect of actual economic growth. To the extent that economic growth drives inflation, the Fed can have more leeway to “taper” versus outright tighten.
The U.S. economy still has plenty of runway to return to pre-pandemic strength, and there is plenty of spare capacity and slack in the labor market to keep prices from moving too high too quickly, in my view. Inflation could very well become an economic issue down the road, I just don’t think it will be a major concern in 2021.
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