“Inflation will be higher and more persistent than people expect.” Mohamed El-Erian, Allianz & Gramercy Advisor

Higher and more persistent inflation may now be an unavoidable economic fact of life for Americans, and it’s starting to make a lot of economists, investors and public leaders worry. They, specifically economists, collectively believe inflation is primed for rapid growth domestically as trillions in federal stimulus spending is layered on top of the Federal Reserve’s loose monetary policy.

This level of unadulterated fiscal spending could mean that investors will have to get used to inflation, higher interest rates, more market volatility and lowered returns on invested capital.

In conjunction to domestic and global inflation concerns, there exist two significant global economic worries for individuals and investors:

• Global supply chain constraints which are significant and will get worst whether it is disrupted supply chains or labor worries, and
• Global tightening of monetary conditions and less liquidity.

But, major shocks to the economy tend to be caused by either a major policy mistake or market accidents. Yet, we’re unlikely to witness double digit inflation in the United States.

"The case for stocks remains strong in relative terms. In asbolute terms, there are two things that very clear. Supply constraints are significant and will get worse … the second thing is we are on the cusp of global tightening," says @elerianm ahead of a busy earnings week. pic.twitter.com/zyRqwHHWvO

— Squawk Box (@SquawkCNBC) October 25, 2021

The Federal Reserve and the Biden Administration contend that the elevated inflation readings will prove transitory. The Fed and Administration view that the current inflation stems chiefly from temporary factors such as supply bottlenecks and a spike in post-pandemic consumer demand.

The August inflation report showed that prices increased by 5.4% year over year in July. Wages increased, too—but not by enough to offset inflation.

And, Americans know inflation when they see it: retail shops and restaurants are raising their prices on consumers, and prices of used cars and trucks were 32% higher in August than they were a year earlier, and workers are discovering bargaining power over wages for certain positions for the first time in years, according to Barron’s. “Inflationary pressures are likely to rise because everyone is spending—including the government—and it becomes a self-sustaining cycle,“ says Karen Karniol-Tambour, co-chief investment officer for sustainability at Bridgewater Associates.

“When you live in a world of abundant liquidity, investors tend to take on too much risk.” Mohamed El-Erian

Congress has assigned a dual mandate for the Federal Reserve: Foster maximum employment and maintain price stability. The FOMC has interpreted maintaining price stability as keeping inflation growing at about 2% a year over the long-term.

Over the past two decades, the Federal Reserve has been unable live up to its two percent inflation mandate. Using the Fed’s preferred gauge of inflation, core Personal Consumption Expenditures (PCE), which tracks price changes over time without volatile energy and food costs, inflation has remained stubbornly below the Fed’s 2% annual target since the 2007 – 09 Great Recession, except for a brief stretch in early 2012 and much of 2018.

Going from a disinflationary world to an inflationary world

Evidence that some of the issues that might spur inflation could abate ahead, particularly some of the supply chain issues. Additionally, unit labor costs remain low, meaning that companies still aren’t spending substantially more for productivity, which also could tamp down inflation.

Federal Reserve Chair Jerome Powell has been resolute in his commitment to seeing the whites of inflation’s eyes before raising rates or paring back quantitative easing. But some market observers believe the Fed is being too lax.

“Financial conditions should remain quite accommodative for a while and in our view risks an overshoot,” said Rick Rieder, BlackRock’s Chief Investment Officer of Global Fixed Income.

The drivers of global inflation are many and complex. They include global economic and policy forces as well as domestic. Yet, it’s important to keep in mind that the rise in inflation isn’t necessarily life altering. Although, policy makers can’t hold on to the “mystical attraction of transitory inflation” when the facts on the grow indicate the contrary, according to Mohamed El-Erian. Given the extraordinary level of fiscal and monetary economic stimulus, inflation may be less transitory than previously thought.

On the "transitory #inflation" narrative, including why the longer it retains an almost mystical hold on the #Fed's thinking, the greater the risk of a policy error whose negative implications could last for years and extend well beyond the US.https://t.co/iEgUxMgcXQ@bopinion

— Mohamed A. El-Erian (@elerianm) October 25, 2021

References:

1. https://www.forbes.com/advisor/investing/inflation-worries/
2. https://www.cnbc.com/video/2021/10/25/mohamed-el-erian-were-not-anywhere-near-risk-of-hyperinflation.html
3. https://www.pimco.com/en-us/insights/viewpoints/want-to-mitigate-inflation-take-a-portfolio-approach
4. https://www.barrons.com/articles/government-economy-stock-market-51633705211