The inflation question is foremost in investors' minds. Everywhere you look, from the front page of the Wall Street Journal to CNBC, it has become the lead story. It's also come up quite a bit in conversations I've been having, and deservedly so. How it gets resolved will be a large driver of how the economy and markets perform going forward.
There is no question that inflation is running hot. The consumer price index is up 4.2 percent from a year ago; producer prices are up 6.2 percent. The Federal Reserve focuses on the inflation measure for personal consumption expenditures (PCE), which is up 3.4 percent.
The Fed has said it thinks the inflation surge, at least when looked at on a year-over-year basis, is overstated because it is built on comparisons to a period when prices were falling during the onset of the COVID-19 crisis. It also thinks any recent pressures are caused by supply-chain issues that should go away as the economy continues to recover. Due to the government's largess with PPP loans and extended unemployment benefits, the recession that we experienced last year is the only one in history where incomes actually rose. Those stimulus checks are being spent now, creating supply issues. The Fed's belief is that six months to a year from now, when things have normalized, we'll no longer be talking about inflation.
The other side of the argument is not so sanguine. There has been tremendous growth in the money supply since the pandemic. It's not just the Fed that has embarked on easy-money policies: Central banks around the world have introduced Quantitative Easing in the past decade and this liquidity is finding its way into commodity markets. However, commodity prices have historically been extremely volatile. Manufacturers often will not pass increased costs on to end users if they think the spikes are short-lived.
The cost of labor is different. Once increases are in place, it is harder to roll them back. There are 10 million fewer people employed now than before last March, despite the help-wanted signs posted everywhere. Talk to any business owner and hear the same thing. Higher wages will work to alleviate that problem, but that would mean we'd have to get used to paying higher prices.
Stable prices are one the the Fed's mandates. It believes that what we're seeing currently is transitory. Looking at the bond market, it appears the Fed is right for now. Yields moved higher in Q1 of this year, but have stopped rising since then. Bond investors don't like inflation for a couple reasons. First, if the inflation rate is higher than the coupon rate you're earning on the bond, then you lose money over time because your purchasing power goes down. The benchmark 10-year treasury currently yields 1.6 percent, and as noted above, inflation is close to twice that. That is not sustainable.
Secondly, we learned how to stop inflation back in the 70s: Raise rates to slow down the economy. Not a good thing for bonds or stocks if that turns out to be the case.