IN THIS ISSUE:

1. Overview – Inflation is Not Nearly Dead

2. Inflation Usually Rises, But Not Always

3. Why Has Inflation Remained Low For So Long?

4. Reasons Inflation Could Come Roaring Back

Overview Inflation is Not Nearly Dead

The US inflation rate has hovered around 1.5% over the last decade, well below the Fed’s target rate of 2% most of the time. Such low inflation for such an extended stretch is quite unusual given historical economic relationships, especially with the economy strong and the unemployment rate near historic lows late last year and earlier this year before the pandemic hit.

Normally, inflation rises when unemployment is very low and, conversely, inflation tends to fall when unemployment is high. Over the last several years, it has done neither and this poses a challenge for economists, financial market participants, policymakers and the general public who must make decisions based on what they expect inflation to be in the future.

Unfortunately, the general public has now been lulled into a potentially dangerous mindset which assumes high inflation is a thing of the past. In fact, the best market estimate of expected future inflation – which is the spread between Treasury bonds which are indexed to inflation and non-indexed securities – indicates that investors expect inflation over the next 10 years to average less than 2% per year. That’s a scary assumption, in my opinion.

There are important reasons why inflation has been subdued for so long and there are many who expect this trend to continue indefinitely. However, there are also equally important reasons to believe inflation will come roaring back before too long, especially if the Fed continues to print money at a historic rate, and if the government continues to run multi-trillion-dollar annual budget deficits. We’ll talk about both possibilities today.