Is Inflation Here to Stay?

Jun 14, 2021 | Marcia Zhou


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Reviewing the ‘transitory’ inflation debate

As we all know, inflationary concerns have been at the forefront of discussions for investors and economists. While still far from the double-digit levels seen during the 1970s and 80s, the inflation rate (+5% year-over-year as of May 2021) has reached its highest point since 2008. While the general consensus is that the persistently low-interest rates and supply shortages mean that we’re in for additional bouts of inflationary upswings, what remains uncertain is how much inflation to expect and how long it will remain.

Will Inflation Persist?

RBC Wealth Management does not currently believe that we are on track for a sustained period of high inflation in the US and other developed countries.

One reason why the inflation we are seeing may be transitory is that despite the Fed injecting liquidity into the system at a record pace, the “velocity” of money has not been keeping up. In other words, the rate at which consumers and businesses have been collectively spending money has not been on par with the growth of new money.

In addition, post-pandemic spending should eventually roll off and lessen inflationary pressures. As things normalize, consumer spending stemming from factors such as pent-up demand from prolonged shutdowns, high pandemic savings rates, and government stimulus benefits should begin to wind down.

Furthermore, COVID-induced supply chain bottlenecks are likely to sort themselves out in tandem with the accelerated vaccine rollout around the world. Hence, prices for commodities and manufactured goods should decrease as supply disruptions subside.

Finally, as of late, the bond and credit markets seem to have been taking inflation concerns in stride. To a certain degree, the 10 Year Treasury Yield should reflect future inflation expectations. As inflation expectations rise, the yield should also rise. After hitting the recent high of 1.75% in April, the yield has stabilized and settled lower to around 1.45%. Surely, it is still too early to claim that inflation expectations have peaked and are already fully priced into the bond market. However, the sizeable jump from the Covid lows of ~0.3% should definitely count for a significant portion of inflation expectations.

The Way Forward for Investors

Eric Lascelles, RBC Global Asset Management’s Chief Economist mentions, “Overall, we would argue that the inflation risk isn’t quite as high as it seems right now, though the annual figure will get worse (with the May data) before it starts to get better into the second half of the year.”

Despite the idea that inflation could be potentially higher than what we’ve become accustomed to over the last decade, long-term investors should, as always, look past “shorter-term” events such as this current spike in inflation and stay the course with their overall investment strategy and asset allocation. Speak to your advisor if you would like to review which holdings in your portfolio may benefit or be impaired by higher inflation expectations.

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