Here’s why investors are so spooked by inflation


For much of the last decade, investors were worried that inflation was too low. Now, they’re getting spooked by signs that the pace of wage and price gains is picking up again.

The latest data on consumer prices is only going to stoke those fears.

On Wednesday, the government reported that U.S. inflation at the consumer level rose much more than expected in January, fueling fears that inflation overall is about to pick up again to potentially dangerous levels. Stock prices beat a hasty retreat.

The latest read on the consumer price index shows that it jumped 0.5 percent last month, surpassing economists’ forecasts for a 0.3 percent increase. Taking out the prices of food and energy, which can swing widely from one month to the next, the index was up 0.3 percent compared with forecasts for 0.2 percent.

The news follows a report earlier this month that showed a strong pickup in wage gains, another inflation barometer. It was the biggest jump in more than eight years.

That brought the recent, seemingly relentless, bull market in stocks to an abrupt halt. After several pullbacks, the S&P 500 stock index had shed roughly 10 percent in a matter of days. Before Wednesday’s report, it had climbed back to levels about 7 percent lower than the all-time high hit Jan. 26. But the CPI news sent investors fleeing stocks again.

Bond investors have also been on high alert for rising inflation. Yields on the benchmark U.S. 10-year note recently shot up to a four-year high.

Here’s why investors are so spooked.

Weren’t investors not that long ago worried about too little inflation? Why the switch now to worrying about too much?

Very weak inflation is a sign of a weak economy, and after the Great Recession, the great fear was that the economy would slip back into recession. For a time, there was a good reason to worry that as the global economy tried to get back on its feet, deflation might take hold.

Deflation is more than just low inflation. Rather, it is when prices start falling and then don’t stop, which means companies make less money and have to pay workers less. When those consumers have less and less to spend, companies have to cut prices further and the cycle continues.

So a little bit of inflation is a good thing. It’s a sign the economy is growing at a healthy pace. That’s why the Federal Reserve has been working to set its interest rate policy with a target inflation rate of about 2 percent.

What do interest rates have to do with inflation?

Generally, lower rates tend to spur economic growth because they make money cheaper for companies and consumers to borrow and spend. That borrowing and spending increases demand, which tends to drive prices higher. The reverse has also been true in the past; when inflation heats up, higher rates tend to cool it off.

The best example in modern history was the Great Inflation of the 1970s, when wages and prices began rising uncontrollably. Several presidential administrations tried, and failed, to contain it. It wasn’t until the Fed jacked up rates, twice, to double digits in the early 1980s that inflation finally subsided.

So why are investors so worried about inflation in the first place?

Investors in financial assets like stocks and bonds are always worried about inflation, because it erodes the buying power of whatever money they make on those investments. If you make 3 percent on an investment, but inflation is also at 3 percent, your real return is zero. The other reason is that higher inflation usually brings higher interest rates in response, from both the Fed (which sets short-term rates) and the bond market (which governs long-term rates.)

Since that early 1980s surge, interest rates have been on a long-term decline, with ups and downs along the way. That gradual decline has boosted economic growth, along with stock and bond prices, with two notable pullbacks in 2000-01 and the Great Recession. Now, nearly four decades later, the U.S. economy continues to grow, albeit slowly, and stock and bond prices have continued to rise.

Source link

Products You May Like

Articles You May Like

The GMAT is no longer the only way into business school
Many forces are in place that could keep pushing rates even higher
JC Penney shares tank on sales decline, profit outlook slashed
Netflix turning Michael Lewis ‘Flash Boys’ into a movie: report
Market illegal sports betting in US not really $150 billion business

Leave a Reply

Your email address will not be published. Required fields are marked *