Last week's inflation numbers were a surprise to the markets and came in at their highest level in decades. The spike in inflation had investors worried that the Federal Reserve may start tightening monetary policy sooner than expected, leading to a sell-off in stocks. Going forward, the big debate will be whether the increase in inflation will prove to be 'transitory' or will it lead to higher long-term inflation. The Fed has been clear on their position that the recent increase is transitory and long-term inflation is not an issue. The chart below helps explain why they are taking this position, and showing the increases to inflation were a result of temporary supply disruptions and a rebound in reopening prices.
We believe the Fed is not likely to overreact to higher inflation in the short-term unless we see one of the following: 1. wage growth that looks persistent; 2. a multi-year housing boom that drives shelter inflation higher; 3. the temporary inflation spikes lead to a change in 'psychology' and a spike in future inflation expectations.
