US consumer price inflation hit an annual rate of 5.4% yesterday. That’s a big number.
Meanwhile, “core” inflation – taking out food and energy – is still sitting at 4%.
It’s not the highest it’s been this year, but it’s certainly well above the Federal Reserve’s target of 2%-ish.
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Looks like that comforting “transitory” explanation is on its last legs.
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We’re not in the 1970s yet. But there’s plenty more inflation to come
As John Authers puts it on Bloomberg, “there’s no longer any sensible way to dismiss this inflation episode as merely transitory.” Even if you get rid of “volatile” stuff like energy, food, housing and used vehicles (yes, I imagine you too may be wondering by this point what’s left), inflation is still above 3%, which is its highest level in 28 years, says Authers.
We are by no means at or even approaching 1970s levels yet, he adds – if you take inflation over two years rather than one, it looks less alarming, though still anything but transitory.
However, you then have to wonder about what’s coming next – this is all happening at a time when labour markets around the world are extremely tight. In fact, we haven’t really seen anything like this before.
In the UK, for example, the data seems to show that we not only have record job vacancies – we’re already at a stage where more people are in work than had jobs before the pandemic broke out. That seems extraordinary and I’d certainly be very interested to see how that all adds up (is it a shift from self-employed to PAYE? Something to do with furlough distorting the stats? A shrinking of the black/grey economy?).
But even if the figures are being warped by the weirdness of the overall situation, one thing is very clear – whether you’re in the US or the UK or anywhere else – workers are in short supply, and that means higher wages.
Meanwhile, winter is coming and energy and fuel prices are high. That’s a form of inflation that workers are particularly sensitive to, and that spells more pressure on wages.
Oh and by the way, this morning we learned that Chinese producer prices are up 10.7% year on year, the highest level in 25 years. So there’s plenty more where this came from.
Markets are starting to believe that this is not a passing phase
The market reaction yesterday was interesting. At first, gold did its usual recent trick of wilting. Then it moved sharply higher. It’s been a while since gold had a significant “win” for the day, so this was notable.
Why? Well, this level of inflation suggests that the Federal Reserve, America’s central bank, has no choice but to start tapering. In other words, the Fed will be tightening monetary policy imminently.
Tighter money means higher interest rates which would normally be bad news for precious metals (not to mention the Nasdaq, which is highly interest-rate sensitive). And yet, gold went up. What gives?
Well, as we’ve mentioned a few times before, the reason that gold tends to do well in inflationary times is not because of inflation as such, it’s because when inflation goes up, “real” interest rates (that is, interest rates adjusted for inflation) go down. Gold historically does well when real interest rates are falling.
If inflation goes up faster than interest rates, that spells falling real interest rates (even if nominal rates are rising). That in turn is good for gold. So overall, this move implies that the market is starting to wake up to the idea that the Fed is going to end up “behind the curve”. In other words, whatever happens with interest rates, they will lag the pace of inflation – at least, until inflation really starts to bite.
If gold and silver start to make a decent comeback, then we could well see the precious metals miners starting to recover some of their poise too. The sector as a whole has fallen sharply from its highs of August last year – indeed it’s in a bear market.
But that means that if this is a genuine recovery and the beginning of an inflationary cycle, then there’s solid scope for a rally. On that front, there are a fair few active funds which invest in gold miners. One straightforward passive play is the VanEck Vectors Gold Miners ETF (LSE: GDX) which tracks the major gold miners.
There are several other interesting points to pick out from yesterday’s market reaction. Emerging markets liked it too. The implication is that investors see emerging markets as somewhere to take shelter from a weaker dollar.
It’s not a great idea to view emerging markets as just one big bucket – Turkey is clearly very different to Vietnam, for example (and, technically, Vietnam isn’t even an emerging market, it’s a frontier one, but let’s park that for now).
However, for the sake of simplicity, there are two “big picture” factors about the emerging market sphere in general that might make it appealing in a more inflationary post-Covid world.
One is that (broadly speaking) their public and private finances are in better shape than those of most developed economies. That means that they can raise interest rates without worrying about bankrupting themselves.
Secondly, they have long memories of crises caused by “hot” money fleeing their shores, and so they will also be inclined to raise interest rates to maintain currency stability against the dollar. We’ve already seen rate rises in several emerging markets.
All of this implies that asset allocations for most of us might need to shift significantly to cope with the new era that we might be moving into. Fewer bonds and US tech stocks, more precious metals and emerging markets?
This is something we’ll be devoting more time to in upcoming issues of MoneyWeek magazine. And of course, we will be discussing inflation and its impact on your portfolio at the MoneyWeek Wealth Summit next month. Book your ticket now if you haven’t already done so – the early bird discount ends on Monday.
