Tag: inflation

Weekly Geopolitical Report – What Population Aging Means for Global Inflation and Growth (April 19, 2021)

Posted on by Rebekah Stovall

by Patrick Fearon-Hernandez, CFA | PDF

One key worry for investors these days is whether fiscal stimulus, loose monetary policy, and accelerating economic growth will spark runaway inflation.  That concern has been a major factor in driving down fixed income prices and boosting bond yields since the start of the year.  However, we’ve been arguing that any acceleration in consumer prices this year is likely to be fleeting.  Much of the expected rise in inflation will simply reflect “base effects” as current prices are compared to the weak prices at the beginning of the coronavirus pandemic one year ago.  Despite recent supply chain disruptions, such as the February freeze in Texas and the grounding of the Ever Given container ship in the Suez Canal, a lot of excess industrial capacity and unused labor exists in the U.S. and other major countries.  The overall high availability of resources should help keep a lid on inflation for some time to come.  In this report, we discuss yet another factor that will probably hamper inflation: population aging.

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Asset Allocation Weekly (April 16, 2021)

Posted on by Rebekah Stovall

by Asset Allocation Committee | PDF

In the NBC mockumentary show The Office, the character Jim Halpert gets tricked into choosing his wife, Pam, as “Employee of the Month.” Perplexed and suspicious, coworkers begin to probe into how Jim’s wife was deserving of the award. Pam, who was also surprised, attempts to justify the result, saying, “I didn’t miss a day, I came in early, I stayed late, and I doubled my sales last month.” Not buying her answer, a coworker rebuts, “Oh, really! From what? Two to four?” In an aside to the camera, Pam replies, “Yup!” This example illustrates how an otherwise shocking statistic can be rendered meaningless when viewed in the proper context. In this report, we will discuss the importance of context when evaluating the Consumer Price Index (CPI) over the next few months and how an expected sharp rise in inflation may not be a cause for concern.

The CPI tracks the monthly price movements of consumer goods and services. The index is based on a weighted average in which services make up 60% of the index and goods make up the remaining 40%. To minimize distortions due to normal monthly variations, the index is adjusted to take seasonality into account as both demand and supply can be affected by seasons. For example, beef demand usually rises in the summer (the “grilling season”), so statisticians at the Bureau of Labor Statistics will adjust for the price effects of this seasonal demand through a seasonal adjustment process. However, these adjustments usually only deal with predictable yearly effects. Unusual weather events or one-off situations are not taken into account. As a result, outlier events such as supply disruptions, war, drought, and, most recently, pandemics aren’t part of the seasonal adjustment process. Thus, the frequently reported yearly change in CPI can sometimes be more reflective of changes in the comparison year rather than actual price pressures.

The chart above shows how the year-over-year change in the CPI will look if the index remains unchanged for the next three months. The grey region represents the start of the pandemic in March 2020 through the end of 2020. The yellow region shows annual inflation if the index remains unchanged from February. Using this assumption, headline CPI would show year-over-year increases of 1.9%, 2.6%, and 2.6%, respectively, over the next three months. The 2.6% figures would be near three-year highs. In other words, barring unforeseen deflation, the CPI report will likely show a steep rise in inflation.

The rise in the index over the next few months can be attributed to goods and services returning to their normal levels. Energy prices, particularly, are primed to be one of the key drivers pushing inflation higher. Fuel prices have risen 34.5% after hitting a 15-year low last May.[1] In general, prices for goods have outpaced services due to stronger demand from people forced to stay home. However, as vaccinations become more ubiquitous and restrictions on movement decline, this trend will likely reverse. Fares for travel and entertainment are expected to pick up as good weather sets in and more states begin to allow people to enjoy recreational activity.

It is also likely that stimulus checks could temporarily lift prices. Over the last few months, prices for durable goods such as used motor vehicles and major appliances have surged. White goods have done particularly well, with prices up 24.3% from February 2020. This suggests that households may have used their stimulus checks to purchase big-ticket items. That being said, this inflation will likely be limited as consumers are less likely to buy more of these goods over the next few years.

In summary, over the next few months, the CPI may not paint an accurate picture of inflation. Because the index does not make adjustments based on major outlier events such as pandemics, base-year comparisons can be distorted. As a result, the upcoming CPI report of annual inflation may reflect a combination of deflation in goods and services in the previous year and fiscal stimulus in the current year. Neither will result in the unfettered inflation that skeptics are warning about as both are one-time events. As a result, any adverse impact caused by these reports in the financial markets will likely be short-lived.

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[1] In fact, last year, oil prices briefly fell below zero.

Asset Allocation Weekly (April 9, 2021)

Posted on by Rebekah Stovall

by Asset Allocation Committee | PDF

One key worry for investors these days is whether massive fiscal stimulus, loose monetary policy, and accelerating economic growth will spark runaway inflation.  That concern has been a major factor in driving down fixed income prices and boosting bond yields since the beginning of the year.  However, we’ve been arguing that any acceleration in consumer prices this year is likely to be fleeting.  Much of the expected rise in inflation will simply reflect “base effects” as current prices are compared to the extraordinarily weak prices at the beginning of the coronavirus pandemic one year ago.  In spite of recent supply chain disruptions, such as the February freeze in Texas and the grounding of the Ever Given container ship in the Suez Canal, there’s also a lot of excess industrial capacity and unused labor in the U.S. and other major developed countries.  The overall high availability of resources will likely help keep a lid on inflation for some time to come.  In this report, we discuss yet another factor that will probably hamper inflation: population aging.

As shown in the chart below, a study we recently conducted suggests that when a country has a higher median age, it tends to have lower inflation in the coming years.  Our study looked at the median ages and inflation experience over time for a sample of 10 major economies, each of which has a relatively comparable measure of “core” consumer inflation (consumer price changes excluding the volatile categories of food and energy).  Countries in the sample ranged from developed nations like the U.S., Japan, and France to “emerging” or recently developed markets like Mexico, South Korea, and Israel.  Across the sample, our study showed that for every additional year of median age, a country’s average annual inflation rate over the coming five years declined by approximately 0.2%.  Similar inflation declines were noted for forward periods ranging from one to 15 years.  For perspective, a one-year rise in median age is what the U.S. experienced when its median age increased from 37.3 years in 2013 to 38.3 years in 2020.

Our analysis suggests population aging holds down inflation primarily through the mechanism of weaker demand.  A separate study that we’ve conducted shows that at least in large, developed countries such as the U.S., people tend to reduce their consumption spending as they approach and then enter retirement (see chart below).  As birth rates fall, average ages increase, and a greater share of the country’s population enters pre-retirement or retirement.  Overall consumption expenditures then grow more slowly than they otherwise would, and the weakening in demand makes it harder for companies to raise prices.

To be sure, plenty of factors can have a bigger impact on inflation in the near term, such as the base effects, fiscal stimulus, and supply disruptions mentioned above.  That explains why the estimated equation in the first chart has a relatively low “R2” (a measure of how well the equation fits the relationship; an equation with a strong fit would have an R2 of 0.60 or more).  Population aging is probably best thought of as an important background factor inhibiting inflation over the longer term, much like technological innovation or globalization.  Population aging is to inflation what a big luggage carrier on the roof of your car is to your top speed: along with the size of your engine, your tire pressure, and other factors, it’s one of many things that can limit just how fast your car can go.  That’s why we think falling birth rates and rising median ages in countries across the world should help convince investors that persistently high inflation probably won’t be a problem until further in the future.

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