Investment strategy
May 12, 2021

COVID distortions boost inflation but the long-term outlook is less troubling

May 12, 2021
Steven Wieting
Chief Investment Strategist and Chief Economist
Malcolm Spittler
Global Investment Strategy
Row of used cars on sale

The US has registered its largest single monthly increase in inflation for 40 years, and a yearly hike exceeding anything seen since the middle of the great recession. But we view most of this as normalization rather than permanent acceleration in the wake of the distortive effects of the COVID pandemic.

  • The US CPI rose 4.2% year-over-year, with 0.8% growth in April alone. The monthly increase was the largest single monthly increase in 40 years, and the yearly increase exceeds anything seen since the middle of the great recession. But this is in line with our expectations that the middle of this year would see very high inflation figures. The world economy is highly distorted by COVID-driven shifts in consumption expenditures resulting in supply bottlenecks.
  • After shortages in goods owing to COVID-driven shifts in consumption patterns, services prices should rebound next. Yet in sharp contrast to more strident inflation hawks, we see most of this inflation as a normalization rather than a permanent acceleration. We look at two-year annualized inflation and see figures roughly in line with Fed targets, and see growth signs in the details of today’s CPI print.
  • Most price increases cut consumer power, but there is one exception, and that is used vehicle prices, which surged by 10% in April, driving nearly half of the entire monthly increase in prices. Instead of cutting consumer power, higher used vehicle prices means higher trade in values, and coupled with very favorable lending terms for new vehicles, means we will likely see a strong summer of vehicle selling which will likely reinforce the business cycle expansion.
  • The Federal Reserve will have a difficult communication challenge ahead as the US shifts further into expansion. We view the GDP figure as the most telling about the direction of the economy versus the lackluster employment and high inflation figures for April. We see strong growth that is coming out of the recovery as the US economy reopens and transitory factors in inflation and employment. But the same three data points could be used to tell a far more pessimistic story, of already tight labor and soaring inflation. We caution against this reading and see the details of the reports as more important than the headlines for charting the future path of the economy.
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