We’ve all seen them…
Higher prices at the pump. Higher prices at the grocery store. Higher power bills.
Inflation is running at 6.8%, the highest level in almost four decades.
Federal Reserve Chairman Jerome Powell has recommended dropping the term “transitory” when discussing inflation.
Even President Joe Biden – eager to put a positive spin on things – no longer insists that higher prices are “just temporary.”
Yet two things stand in sharp contradiction to this abject surrender by “Team Transitory”…
The bond market. And the gold market.
Both are shouting loud and clear that high prices won’t last.
And while these markets may be wrong, they have a long history of being dead right. So it’s worth paying attention.
Economists, investment analysts and government officials are generally smart people with large staffs, the latest technology and access to plenty of data.
However, they are no match for the markets themselves, which rapidly and instantaneously incorporate all available information into the price of publicly traded securities.
Investors have a lot more on the line than just their reputations. They are risking trillions of dollars.
And they clearly expect a relatively quick return to low inflation.
How can we be sure? Because bond yields have hardly budged – and gold has actually sold off.
Let’s start with bonds…
Bonds have experienced a sell-off in the first 10 days of this year. But the current yield on the benchmark 10-year Treasury is still a remarkably low 1.8%. Subtract an inflation rate of 6.8% and you have a real (inflation-adjusted) yield of -5%.
If fixed income investors expected persistent high inflation, yields would be sharply higher.
(And bond prices – which move inversely – would have spiked even lower.)
Bond investors are easily spooked, driving yields higher at the slightest whiff of higher prices. But they aren’t scared enough to send yields anywhere close to the current level of inflation.
Let’s turn to gold…
The yellow metal has been an inflation barometer far longer than we’ve had stock and bond markets.
The “barbarous relic” has been a store of value and a medium of exchange for thousands of years.
Gold bullion started 2021 at $1,944 a troy ounce but – despite the sharp rise in inflation – it has since retreated to less than $1,800.
If inflation is likely to remain high, why has gold depreciated rather than appreciated?
Some will say it’s because gold has been replaced by cryptocurrencies, the new “digital gold.”
A speculative asset with no tangible value, no widespread acceptance (except among extortionists and black marketeers) and no history of long-term investment performance will replace a centuries-old monetary hedge?
I don’t think so. But magical thinking is much in vogue in some quarters these days.
(More on that in another column.)
In short, both gold and fixed income markets are signaling that the spike in inflation will be short-lived.
Here’s why you should believe them…
Nobel Prize-winning economist Milton Friedman famously said, “Inflation is always and everywhere a monetary phenomenon.”
By that he meant that higher prices are the result of the money supply increasing faster than output. Too much cash chasing too few goods.
That is exactly what we’ve seen over the past two years…
To combat the pandemic and a potential economic collapse, the federal government took extraordinary measures.
For starters, it spent over $13 trillion.
The Federal Reserve adopted a massively accommodative policy, flooding the system with money and simultaneously suppressing yields with a multitrillion-dollar bond-buying program.
Politicians didn’t want to risk doing too little. So they overdid it, showering COVID relief on Americans.
Meanwhile – around the world – the pandemic shut down factories, ports, transportation centers, warehouses and stores.
These can’t be restarted – or catch up – in the blink of an eye.
The predictable result? Way too much demand chasing far too little supply – and the highest inflation in nearly half a century.
This is still a problem. But it’s about to enter the rearview mirror.
The big COVID relief packages are behind us. The last one – the Democrats’ Build Back Better plan – is stalled.
The Federal Reserve is tapering its bond-buying program and has pledged to take short-term rates higher this year.
And businesses everywhere are ramping up production, unclogging ports, hiring laborers, transporting goods and doing everything possible to meet demand.
Not out of a sense of patriotism or altruism or “community.” But out of self-interest.
Shortages raise prices. High prices create opportunities for profit. And self-interested individuals move heaven and earth to meet all our wants and needs.
It’s a beautiful thing. Even if some insist they see nothing but selfishness and greed.
(The dogs bark but the caravan rolls on.)
Bottom line? An overdue pullback in deficit spending, a less accommodative Fed and the undoing of the Great Snarl in the global supply chain will cause inflation to recede by midyear.
That’s positive for the economy, corporate profits and share prices.
And it makes the recent pullback in the stock market an opportunity.