Inflation is here and getting worse. The stats paint the picture and speak for themselves. The U.S. has hit the highest inflation levels in 40 years. The U.S. consumer price index increased 7%, which is the largest single-year rise since 1981. Wholesale prices spiked the fastest ever at 9.6% in November. The average wage growth was 4.7% in the U.S., notably less than the rate of inflation.

Higher wages help fuel inflation because companies need to raise prices for goods and services in order to cover the increased costs. It’s a cycle in which wages rise but costs rise even faster. If you’ve been to the grocery store or the gas pump, you can definitely feel the pinch. Oil has risen to the highest level in seven years. Should you be alarmed? It all depends on your situation.

What Is Inflation?

Inflation occurs when broad prices for goods and services rise, while purchasing power simultaneously falls over a given period of time. It is the rate of increase in prices for consumers measured over a period of a year. Thus, the consumer price index (CPI) is used to gauge inflation. The CPI measures inflation as experienced by consumers in their daily living expenses. The CPI is the rate of inflation.

CPI Data

The consumer price index (CPI) report is released monthly and measures the average change of prices paid by urban consumers for a market-based basket of products and services. The U.S. Bureau of Labor Statistics (BLS) collects the data through two surveys, including prices for commodities and services and prices for rent (housing). Every month, about 94,000 prices are crunched to compute commodities and services indexes. 

Rising PPI Can Drive Higher CPI

The producer prices index (PPI) is how much businesses pay. A higher PPI results in businesses passing on the price hikes to the consumers, which can push up the CPI. Wages need to rise to enable consumers to continue paying higher prices, which enables producers to pay higher prices as the circle continues, resulting in higher inflation.

But higher PPI doesn’t always result in inflation. If prices get too high, then consumers step back from spending, which builds up supply and causes prices to fall back down. Currently, wages are not rising as much as prices are rising. This will likely result in consumer spending cutbacks. This was reflected in the December 2021 retail sales report which indicated a 1.9% decrease from November 2021, however, still up 16.9% from December 2020. 

This decrease could be a sign that consumers are feeling the pinch and pulling back on their spending to some degree. Keep in mind, the retail spending report is mostly composed of consumer discretionary (nonessential) products, which tend to rise during economic growth periods as disposable income rises. These include items like apparel, restaurants, leisure, cars and parts, and general merchandise. Whereas consumer staples are essential products used on a daily basis like food, toothpaste and other personal products. However, the pace of rising wages still falls short of CPI growth, thus rising prices and diminishing buying power continue to drive inflation higher.

What Causes Inflation?

There are generally three types of inflation defined by the underlying cause. Rising demand and falling supply cause prices to rise (demand-pull inflation). However, rising production costs can also result in higher prices (cost-push inflation). Rising labor costs and wages can also cause prices to rise (built-in inflation). Inflation can take years to spawn, and while it has exploded to the upside upon the reopening phase post-pandemic, the seeds may have been planted years ago with the Federal Reserve monetary policy resulting in cheap money aplenty. 

Compounding Problems With Covid-19

The pandemic accelerated inflation but also distorted it. The mandated pandemic-related lockdowns were temporary, which fueled pent-up demand that would outstrip supply upon the economic reopening. Like stretching a rubber band to its extreme, holding and then letting go, as it snaps back furiously. The government-imposed lockdowns caused supply shortages to develop, as businesses and factories substantially reduced output to prevent oversupply. Chip fab factories had already scaled down production before the pandemic hit, not anticipating the demand that quickly increased.

The slowdown caused a supply glut, which then turned into a massive supply shortage when the reopenings and economic restarts occurred. Global supply chains felt immense pressure and disruption as economies attempted to get back on track. A shortage of supply and labor coupled with rising raw materials and logistics costs triggered prices to surge. The federal stimulus and unemployment programs made it difficult to get workforces back online, as many were better off collecting benefits rather than returning to work. This caused employers to have to pay more to find talent, creating rising wage pressures in a tightening labor market.

Omicron Pressures

The latest surge of the omicron variant of Covid-19 has caused further disruptions in the supply chain and logistics as workers take absence and quarantine. U.S. airlines have canceled thousands of flights due to worker shortages from Covid-19. Omicron is the fastest spreading variant, and while vaccination and boosters can lessen the severity to avoid hospitalizations, it doesn’t completely prevent the spread of it. The good news is that the side effects are not as severe as earlier strains, and the rate of hospitalizations has significantly decreased for those who are vaccinated.

The January 2022 Federal Open Market Committee (FOMC) meeting repeated the December meeting notes in that inflation has gone too far above its 2% target. It looks like it’s time to end quantitative easing in March and raise interest rates amid a strong labor market. The way I see it, consumers should be relieved that inflation should fall back. Investors should be concerned that financial assets like stocks, collectibles and real estate will also deflate in value.

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