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Key Points for the Week

  • Consumer prices surged 0.8% supported by price increases in autos and other consumer products.
  • Retail sales were flat and missed expectations for 0.9% growth as declines in general merchandise and clothing purchases cancelled out gains in motor vehicles and restaurants.
  • Industrial production gained 0.7% and has surged 16.5% in the last year from COVID-led declines.

Ever since the financial crisis, central banks have pursued expansionary monetary policies to encourage reflation and avoid deflation. Well, it’s taken some time, but inflation is finally here.

Last week, major stock indices in the United States moved lower after inflation, as measured by the Consumer Price Index (CPI), was four times higher than anticipated, reported Ben Levisohn of Barron’s.

Higher inflation is the result of a supply and demand imbalance. As the pandemic has receded in the United States, consumers have emerged eager to spend money – so eager that consumer spending is about 5.5 standard deviations above average. That’s a lot.

The problem is finding stuff to buy. The Economist explained:

…red-hot demand is increasingly met slowly or not at all…Nowhere are shortages more acute than in America, where a boom is under way. Consumer spending is growing by over 10 percent at an annual rate, as people put to work the $2 trillion-plus of extra savings accumulated in the past year.

The Economist

There are two supply challenges. The first is the supply chain. There is a shortage “of everything from timber to semiconductors,” which are essential to building other products. In addition, shipping containers have become a scarce resource, causing the cost of shipping goods from China to the United States to triple, reported The Economist.

The second is labor. This week’s higher-than-expected inflation data mirrored last week’s lower-than-expected employment data. No one is certain why the employment numbers were lackluster, although theories abound. Regardless, there are limits on what companies can produce when they have too few employees.

The question is whether supply chains can be straightened so demand for goods and services can be met. If so, higher inflation may prove transitory as the Federal Reserve and some economists anticipate. If not, inflation may stick around. Time will tell.

This Week in the Markets

The U.S. economic picture is looking more muddled than expected. The Consumer Price Index rose 0.8% last week. Used automobile prices rose quickly in response to the semiconductor shortage limiting new car production and demographic trends boosting demand. Retail sales were expected to build on last month’s stimulus-led surge but instead were flat. Industrial production remained a bright spot, adding 0.7% last month as manufacturing demand remained strong.

The number of open jobs rose to 8.1 million in March, providing additional evidence increased unemployment benefits are curtailing the available pool of workers. As the country steadily reopens, filling some of the 1.2 million open positions in hotels, restaurants, and similar industries will be important to fuel a sustainable recovery. Initial jobless claims fell another 34,000 to 473,000.

Markets were volatile last week. The S&P 500 moved by more than 1% in four of the five trading days. The S&P 500 slid as the inflation surge unsettled markets and raised concerns about interest rate increases. The MSCI ACWI Index dropped as declines abroad were slightly higher than in the U.S. The Bloomberg BarCap Aggregate Bond Index didn’t respond well to the inflation data either and dropped slightly. Bond prices fall when interest rates rise, and rising inflation can often lead to higher rates.

Chinese retail sales and industrial production will headline economic data released this week, and the Federal Reserve will release the minutes from its latest meeting. Given the big increase in U.S. consumer prices, similar data releases in the eurozone, United Kingdom, and Japan will garner extra attention.

Recovery

Last week, the U.S. inflation rate, as measured by the Consumer Price Index, rose 0.8% from the previous month and is now up 4.2% over the last year. Much of this jump was due to what statisticians call a “base effect,” which means the starting point for the data was influenced by special circumstances. In this case, prices for several goods dropped sharply during the initial stages of the pandemic. One year later, inflation looks like it is jumping rapidly because it is being compared to a low point. Over the next couple months, the starting point moderates and the base effect will be eliminated.

But the base effect is only part of the story. The monthly increase of 0.8% is quite large. Sometimes big swings in inflation are caused by two of the more volatile elements: food and energy. But energy prices dropped last month, and food prices only rose 0.4%. Core inflation, which excludes those two areas, rose 0.9% compared to the previous month.

The impetus for rising core inflation came down to five segments that accounted for 0.57% of the 0.9% increase. The most notable segment was used cars, whose prices jumped more than 10% last month and accounted for more than one-third of the monthly increase in core inflation. Semiconductor shortages have curtailed the production of new cars while demand is rising as people move to less densely populated areas. The semiconductor market isn’t flexible enough to make up the shortages quickly, so the market has reacted by pricing used cars higher.

The other four segments were all related to travel and events. This group included car and truck rentals, airline fares, sporting event ticket prices, and hotels. Car and truck rental prices surged 16.2% last month. The other three were up between 8.8% and 10.2%. None was as impactful as used cars prices, but collectively they accounted for a 0.22% increase in core inflation. Flexibility also mattered here. All these areas have struggled during the pandemic and were not able to ramp up supply rapidly enough to meet increased demand.

The important question isn’t whether inflation will be high temporarily, but whether it will last. Our view is the economy should be able to adjust as long as government policies don’t curtail its flexibility. Inflation is sometimes defined as too much money chasing too few goods. With free-flowing stimulus money meeting supply constraints and only a partial reopening, prices spiked higher.

Long-term inflation is only likely to take hold if flexibility is taken away from the economy. Supply constraints in semiconductors and timber have pushed prices higher and affected many markets. Those prices should come back down as long as companies have the incentives to respond by increasing supply. If energy prices increase, energy companies need the flexibility to produce more. If the demand for labor is higher, policy incentives should not curtail the supply by paying people more not to work than they could make by having a job.

Prior to COVID, the U.S. economy had very low inflation, in part because it was flexible. Unless policies change, we expect inflation to move to between 2% and 3% in coming months.

SECURE Act

When the SECURE Act was passed into law in early 2020, there were many substantial updates that affected retirement account rules that had previously been in place for years. One of the more substantial changes was the elimination of the stretch IRA for non-eligible beneficiaries. This new rule requires that most non-spousal beneficiaries of retirement accounts after January 1, 2020 must distribute the entire inherited account within 10 years of the account owner passing away. Prior to this change, beneficiaries of retirement accounts could use their own life expectancy to take distributions from the inherited account. This new 10-year rule could potentially push beneficiaries into a higher tax bracket and may require account holders and beneficiaries to review their current estate plans.

Another change in the SECURE Act was that individuals can wait until they reach the age of 72 before taking required minimum distributions. Before the SECURE Act was passed, individuals with retirement accounts were required to take distributions no later than April 1st of the year they turned 70 ½. This new age limit does not apply to individuals who turned 70 ½ before 2019.

If you have any questions about the SECURE Act and how it might affect your financial planning goals, please contact us.

Confidence is Returning

The big news last week was the announcement from the Centers for Disease Control (CDC) that fully vaccinated Americans can resume normal activities without wearing masks or social distancing, except where required by law. Suffice it to say, people are ready to return to normal.

Results from the latest Axios-Ipsos Coronavirus survey, conducted in early May, found Americans were feeling more optimistic. Among those surveyed:

  • 59 percent had visited friends or relatives during the previous week.
  • 54 percent had gone out to eat during the previous week.
  • 31 percent had made plans for the summer.
  • 18 percent had a stronger sense of emotional well-being, a six-point jump from the prior survey.
  • 60 percent indicated trips to salons, barber shops, and spas were low- or no-risk activities, up six points from the last survey.

If your exuberance about resuming “normal” life has been tempered by a reluctance to change the routines you’ve adopted during the pandemic, you’re not alone. Medical experts at Northwestern University explained:

The emotional impact of this past year may linger with us for longer than we might expect. The key is not to feel forced to snap back into a routine overnight. Give yourself time and understand that your emotional journey back to freely socializing in vaccinated cohorts may look very different from those around you.

Medical experts at Northwestern University

Delays in Tax Refunds

The Taxpayer Advocate Service (TAS) has stated that it is aware that taxpayers are experiencing more refund delays this year than usual. Typically, the IRS processes electronic returns and pays refunds within 21 days of receipt. However, the high-volume of 2020 tax returns being filed daily, backlog of unprocessed 2019 paper tax returns, IRS resource issues, and technology problems are causing delays. Once a return is processed by the IRS and loaded onto the agency's systems, TAS may be able to assist with delayed refunds if taxpayers meet case acceptance criteria. TAS has a case criteria tool that can be used to determine if TAS may be able to offer assistance. www.taxpayeradvocate.irs.gov/can-tas-help-me-with-my-tax-issue/.

Be Aware of New Text Message Scam

The IRS and Security Summit have issued a warning regarding a new text message scam which cites the availability of an economic impact payment. The goal is to have the recipient reveal bank account details. If you have any questions about this scam, please contact us.

Did you Know? This Week in History

May 20, 1873: Levi Strauss and Jacob Davis Receive Patent for Blue Jeans

On May 20, 1873, San Francisco businessman Levi Strauss and Reno, Nevada, tailor Jacob Davis were given a patent to create work pants reinforced with metal rivets, marking the birth of one of the world’s most famous garments: blue jeans.

In San Francisco, Strauss established a wholesale dry goods business under his own name and worked as the West Coast representative of his family’s firm. His new business imported clothing, fabric and other dry goods to sell in the small stores opening all over California and other Western states to supply the rapidly expanding communities of gold miners and other settlers. By 1866, Strauss had moved his company to expanded headquarters and was a well-known businessman and supporter of the Jewish community in San Francisco.

Jacob Davis, a tailor in Reno, Nevada, was one of Levi Strauss’ regular customers. In 1872, he wrote a letter to Strauss about his method of making work pants with metal rivets on the stress points–at the corners of the pockets and the base of the button fly–to make them stronger. As Davis didn’t have the money for the necessary paperwork, he suggested that Strauss provide the funds and that the two men get the patent together. Strauss agreed enthusiastically, and the patent for “Improvement in Fastening Pocket-Openings”–the innovation that would produce blue jeans as we know them–was granted to both men on May 20, 1873.

Strauss brought Davis to San Francisco to oversee the first manufacturing facility for “waist overalls,” as the original jeans were known. At first, they employed seamstresses working out of their homes, but by the 1880s, Strauss had opened his own factory. The famous 501 brand jean, known until 1890 as “XX”, was soon a bestseller, and the company grew quickly. By the 1920s, Levi’s denim waist overalls were the top-selling men’s work pant in the United States. As decades passed, the craze only grew, and now blue jeans are worn and beloved by men and women, young and old, around the world.

Weekly Focus

I don’t need time. I need a deadline.

Duke Ellington, American Composer

We must have ideals and try to live up to them, even if we never quite succeed. Life would be a sorry business without them. With them it’s grand and great.

Lucy Maude Montgomery, Author