Is inflation here to stay? This is among the most-asked questions facing the U.S. economy—and the answer has ramifications for businesses and investors in a range of industries, from airlines to consumer electronics.
I believe inflation will fall back to around 2.5% by the end of next year, putting it slightly above the Federal Reserve’s 2% target. The combination of unprecedented fiscal and monetary stimulus and pandemic-related supply constraints will cause U.S. inflation to remain above that mark over the remainder of this year and into 2022. That appears to be a certainty.
The big question is what will happen as we get deeper into next year. The delta variant is the wild card because it has the potential to prolong inflation if it continues to cause an imbalance between consumer demand and available supply. But while it’s a legitimate concern, my view is that delta’s impact will gradually wane through next year, as it is proving to be a catalyst for people to get vaccinated, especially in states where vaccination rates are below 50%.
While GDP has already rebounded to pre-pandemic levels, GDP growth will continue, albeit at a much slower rate, through the balance of this year and into next. That will be a function of manufacturers being better able to provide enough supply of goods to meet consumer demand and consumers continuing to increase their spending on services at the expense of durable goods, as schools and offices reopen.
That, in turn, will lead to a gradual taming of inflationary pressures through the remainder of 2021 into 2022. My view is that the current 4%-5% inflation rate will diminish to around 3% by the end of 2021 as supply chain and labor markets stabilize, and settle around 2.5% by the end of next year.
The run-up in consumer prices cooled slightly in August to 5.3% over a year ago, a sign that although inflation is higher than normal, the White House and Federal Reserve may be beginning to see the slowdown in price gains they have been hoping for.
Policymakers have consistently argued that this year’s burst of inflation has been tied to pandemic-related quirks and should prove temporary, and most economists agree that prices will climb more slowly as businesses adjust and supply chains return to normal. The major question hanging over the economy’s future has been how much and how quickly the inflationary burst will fade.
Lower inflation would be positive for airlines, manufacturers, food and apparel retailers, consumer product companies, trucking and shipping firms and consumer-electronics companies. As prices decline for raw materials such as oil, steel, plastics, cotton, wool and components, profit margins for these companies will stabilize—or improve for those companies that have held back on passing along those higher input prices to customers. Stabilizing or improving margins are, of course, just one key for the future growth in earnings for many inflation-impacted companies.
The second key to the positive impact on industries is the reduction of supply-chain bottlenecks caused by shipping constraints and shortages of key parts—factors that have plagued the auto industry over the past year. It is estimated that nearly 5.2 million passenger vehicles will be lost from global production in 2021.
Supply-chain issues will get resolved with the growth in vaccinations, and the rebound of material flows and productive capacity across key supply chain links in Malaysia, Vietnam, Singapore and China. The normalization of supply chains will further improve revenue generation, resulting in increased profitability, particularly as gross margins stabilize or improve.
As a result, earnings growth should continue to improve for supply chain-impacted businesses in 2021 and 2022.
As the pandemic diminishes—thanks to the rise in vaccinations, both voluntary and those mandated by employers—that will also reduce labor costs, which will further drive down inflationary pressures. Many workers are still sitting on the sidelines: That fact was confirmed by the latest release of the Job Opening and Labor Turnover Survey (JOLTS) last week. It found that in July there were 10.9 million job openings vs 8.7 million people unemployed. But that also implies a reserve level of labor market slack that is likely to return to the workforce over the next 12 to 18 months.
Not everyone agrees that the inflation we are experiencing is temporary and will be tamed gradually. Some argue that increased housing prices, rents, wages and energy prices will remain realities after the pandemic subsides, causing elevated levels of permanent inflation. Others argue that with the U.S. trade deficit at 3.9% of GDP and a federal deficit of 10.3% of GDP, the dollar will depreciate, driving higher prices, especially for imported goods and services.
But I don’t subscribe to that theory. To me, it’s clear that after the initial surge in demand as the economy reopens, supply and demand will normalize through 2022, which will put less upward pressure on prices for the future. Others, too, believe that the current rise in inflation in just temporary: According to the Philadelphia Federal Reserve Survey of Professional Forecasters’ second-quarter findings, CPI inflation is expected to average 2.3% over the 10 years from 2021 through 2030.
A reduction in inflation through 2022 would be good news for corporate earnings—and thus for businesses and investors, too.
William J. Fink is executive vice president and head of U.S. middle-market banking for TD Bank.