April 16, 2021

The vaccination campaign in the U.S. is well underway with roughly 2 to 4 million people being inoculated per day, which is laying the groundwork for the reopening of the economy in 2021. Additional assistance is coming in the form of staggering amounts of fiscal and monetary policy stimulus and many market participants are beginning to wonder if inflation will elevate for a sustained period to a level beyond the Fed’s current comfort zone. Anecdotal evidence in the Fed’s Beige Book, which was released on Wednesday, showed that input prices are rising due to supply chain constraints, normalizing consumer demand particularly in the service sector and low base effects. Corporate margins are being pressured and certain companies are beginning to pass price increases along to consumers. Moreover, the Fed is expecting inflation to run a bit hot over the next few months and thanks to its new average inflation targeting regime, it will be patient as inflation climbs. The Fed considers inflation a process as opposed to a concentrated segment of elevated data points and the structural deflationary forces that have been evolving for decades are still significant factors. One of the most important variables in sustaining true and non-transitory inflation is the level of slack in the labor market. Significant progress is being made in the labor market, but as of March nonfarm payrolls were still over 8 million jobs less than prior to the start of the pandemic. Nevertheless, wage pressures are starting to surface particularly in low paying jobs located in certain sections of the U.S. as labor supply is being constrained by public transportation short- ages, health safety concerns, childcare complications and government financial support. The Fed is paying close attention to the labor market and will need to feel confident that significant progress has been made towards obtaining maximum employment to adjust its current monetary policy stance. Moreover, forward guidance will be key in dictating the path of potential monetary policy removal. Right now, the Fed is in a wait- and-see mode and if inflation moves beyond the Fed’s projections it could produce heightened financial market volatility and weigh on asset valuations. The previously listed scenario is not our base case assumption in the near term, but the inflation situation is evolving quickly and does require close monitoring at this juncture.

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