There will be always something to worry about. Right now, one big headline worry in the equity market is inflation.
What Is Inflation?
Inflation is the rate at which the value of a currency is falling and consequently the general level of prices for goods and services is rising. In the United States, CPI or Consumer Price Index is the metric by which inflation is measured. Recently we have been seeing headlines with concerns of rising inflation in the coming months due to the stimulus and spending packages passed by Congress.
Most economists do not expect long-term inflation to be a problem; they do, however, see that we could have short-term supply problems as the crisis begins to slow down, which could lead to higher prices. One of the major banks, JP Morgan, has a model showing labor and housing as far and away the largest drivers of inflation.
As their article points out, there is still a decent amount of slack on the employment side. Unemployment is expected to fall below 5% this year, but is not anticipated to reach the pre-pandemic level of 3.5% until 2023.
Additionally, housing appears to be tame. Housing prices are up; however, consumer inflation comes from housing rental rates, not home prices, and overall rental inflation is falling. This would seem to indicate that inflation will most likely occur in 2023 or beyond rather than in the next couple of years.
Another factor contributing to inflation is the velocity of money.
What Is The Velocity Of Money?
The velocity of money is a measurement of the rate at which money is exchanged in an economy — or the number of times that money moves from one entity to another. It also refers to the number of times a unit of currency is used in a given period of time. Simply put, it is the rate at which consumers and businesses in an economy collectively spend money.
Below is the velocity of M2 for end-of-year. From the beginning of 2020 (1.379x), it dropped 18% to 1.134 by year end.
You might think of velocity as the number of times money exchanges hands. Since money is not “moving” at historical norms, just where is all this money? Bank reserves of depository institutions have increased by 95% from $1.7T in the beginning of 2020 to $3,345T by February 2021. This is an indication that banks are not lending and individuals are not spending.
In the next few weeks, we certainly could see an increase in supply shortages and empty shelves as employment continues to recover from the shutdown. This, coupled with the fact that money is sitting in banks instead of being spent, one could expect that it will be some time before Inflation becomes a problem.
Senior Trust Officer, HFG Trust
Inflation can be a cause for concern for many investors, and is often hard to distinguish whether it is a short-term change or long-term transition.
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