Last week, the September Consumer Price Index (CPI) was reading at 0.2% month-over-month, the slowest pace in the last four months. Food prices came in weaker than expected and grocery store food prices declined broadly, suggesting the supply-and-demand shock from the lockdown and pandemic has been somehow mitigated. Mobility-related component prices, such as hotel rates, airfare and ship fare, turned negative after a sharp rebound in August. However, used car prices were an exception as they climbed 6.7% month-over-month, representing the largest increase in 51 years. If we exclude the used-car-price contribution, the September monthly CPI would have been slightly negative. With the Federal Reserve (Fed) cutting interest rates to zero and buying record quantities of bonds to finance fiscal stimulus, why haven’t we seen any inflation?
Since March, the Fed has helped boost money supply by over $3 trillion, with annual money supply growth north of 23%. Morgan Stanley Chief U.S. Equity Strategist Mike Wilson said, "The risk of higher inflation may be greater than it's ever been." In fact, we are still far from the Fed’s 2.0% average inflation target. The shortfall in inflation is driven by another important component — the velocity of money, a measurement of the frequency at which money is exchanged in the economy. As seen in this week’s chart, money velocity has plunged to an all-time low of 1.09, even though the Fed has printed trillions of dollars. The decline is partly explained by cash sitting idly in reserve accounts at the bank as opposed to being lent. Tighter lending standards are restricting loan supply, while pandemic-driven economic uncertainty is limiting demand.
If there is neither supply nor demand for loans, the economic recovery in the United States will likely slow dramatically going forward. Money velocity will be a key metric for investors to understand that better economic growth will help boost wages and overall inflation, as opposed to simply asset price inflation and possibly the next bubble.
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This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
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