Transitory Inflation? The Debate Continues

A Destination We Won’t Understand Until We Get There

American markets today, Tuesday, viewed several hours before opening at 9:30 a.m. EST appear poised for a mixed start. At time of writing the Dow is in the green while the S&P 500 and Nasdaq are in the red. However, the S&P 500 is slowly climbing and could make it into positive territory before or after market opening, though that is by no means guaranteed. Canadian markets are looking positive.

European markets are open at time of writing and are in positive territory and may continue that way for the day. “A stronger start for European markets has been seen this morning, although weakness in commodity prices has held back UK mining stocks,” explains Chris Beauchamp, Chief Market Strategist at London-based brokerage IG Group.

“Early gains for the FTSE 100 and other European markets have been walked back, and with month- and quarter-end looming the hunt is on for reasons to cut back on risk,” he says.

Amongst precious metals, the safe havens of gold and silver are down.

Amongst currencies, the British pound sterling, Euro and Canadian dollar are all down against the American greenback. That relationship could change later this week, according to Jeremy Thomson-Cook, Chief Economist at London-based payments specialist Equals Money. “Oil prices have been driving moves in a lot of currencies in the past few weeks and an OPEC meeting starting Thursday will continue that trend,” he says.  “We expect that the world’s leading petroleum export countries will decide to increase their output of oil by as much as 500 million barrels a day following strict cuts during the pandemic as fuel demand cratered.”

The Euro will continue to underperform in the short-term since the Eurozone is not facing the same kind of change in messaging on stimulus and rate increases as the greenback in the United States, Thomson-Cook explains.

Several scheduled events are certainly worth checking for what they telegraph about the economic recovery. The Conference Board releases its consumer confidence index for May today.

Tomorrow, the ADP National Report could show a large surge in private payrolls for May.

On Thursday, the Labor Department releases its total initial claims for unemployment benefits data for the week ending on June 26. On the same day, the Commerce Department releases data for construction spending in May.

Also on Thursday, Walgreens Boots Alliance reports third-quarter results and investors will be looking for analysis of the vaccination program and the remainder of 2021.

On Friday, the Labor Department is scheduled to release the non-farms payroll report. The report excludes farm workers and those who work in non-profit organizations, government and private residences. In fact, Thomson-Cook at Equals Money suggests that the American dollar will remain in a holding pattern until this release.

The debate will likely continue this week – and perhaps next week -- over whether inflation is ’transitory’ as suggested by Federal Reserve Bank Chairman Jerome Powell and others. It is possible that this is a destination that we won’t understand until we get there --- that is -- a definite forecast is near-impossible, according to Gavin Graham, London-based financial analyst and former chief investment officer for several major banks. “While I am not suggesting inflation will reach double digit levels as in the 1970s and early 1980s, I do suggest that investors should be aware that central bankers have no more idea than the average investor as to how high inflation will rise.” Graham says. Investors have no means of controlling the outcome of this discussion. “Anyone who has entered the market since the early 1980’s has no experience in what inflation can do. They may about to be unpleasantly surprised,” he says.

Graham says that history proves the point.

During the 1960’s, the government under Democratic President Lyndon Johnson attempted to fund both the Great Society social programmes like social security, Medicaid and Medicare and the Vietnam War without raising taxes to pay for either.

His policy was nicknamed “guns and butter” and while inflation stayed relatively low for a few years in the mid-1960s, once investors realized that government borrowing and spending meant higher prices, inflation started to accelerate and bond yields shot up.

For those who have only a vague recollection or no recollection at all about the phrase ‘guns and butter’ it refers to the choices governments make between the military – the guns -- and social spending—the butter -- usually meaning there must be a trade-off.

LBJ didn’t want his Great Society push hobbled by the increasing costs of the Vietnam War and ran big deficits to fund both. That led to persistent inflation as money was printed to pay for the expenditures not covered by taxes.

Inflation reached 12% in the United States, and 25% in the United Kingdom in the 1970’s, Graham recalls, and bonds became nicknamed as certificates of confiscation as their value was eroded by rapid inflation. Discontent with existing governments and their failure to deal with the problem led to the rise of Ronald Reagan in the United States and Margaret Thatcher in the United Kingdom.

Al Emid is a financial journalist broadcaster and author. His next book. The 2021 Emid Report on Volatility is scheduled for a Fall release.