“Transitory” is the preferred word to describe inflation these days. Central bankers love it, because it means they can continue their easy money policies. Investors love it, because it means the markets’ party goes on.
It is also vague enough to allow for a big margin of error. The dictionary lists as the main definitions for the word “transitory”: “lasting for only a short time”, “not permanent”, and “temporary”.
Each of these definitions is unhelpful for a precise analysis of what is actually likely to happen to inflation. How short is a short time? Half a year? One year? Two?
In the same vein, what does temporary mean? And, rather self-explanatory, “not permanent” does not really offer much insight either. Nothing is permanent, at least not that we know of.
Still, most investors seem to believe that the price rises we have seen will only be temporary. In the June Bank of America global fund managers’ survey, 72% of respondents said they thought inflation is transitory, while 23% think it is permanent.
The minority view is right, in my opinion. Unfortunately, as I have said before, we are seeing the bad kind of inflation.
Commodity and food prices have jumped during the Covid-19 pandemic and there is little likelihood that they will fall back.
Central banks’ easy policies have inflated stock and bond prices and most worryingly, house prices, which in many countries are increasing by 10% or more per year.
On the other hand, the pandemic has restructured the workforce to some extent, forcing some people who were particularly vulnerable to retire early, while others have switched jobs during the lockdowns.
Another, more subtle change took place at the level of mentality. The tragedy of death and suffering that took place all over the globe has caused people to stop and think about what is truly important for them.
The reopening of economies is throwing the imbalances in the workforce created by the pandemic into the limelight.
Working from home, working flexibly and spending more time with loved ones have taken on a new significance, and this is could push up labour costs.
It is likely that salaries for many sectors will have to increase quite sharply, and while this is good for employees, at a macroeconomic level it could exacerbate inflation.
Stock markets sold off heavily last Friday on fears that central banks will have to tighten policy sooner than expected, but that probably will not happen to any serious extent.
No central bank wants to be held responsible for the bursting of an asset price bubble, and there are several hugely inflated bubbles floating around.
Besides, inflation reduces debt simply by eroding the real value of debt assets, and in a world that is drowning in debt anything that would cut its value is welcomed.
So, what is more likely is that asset price rallies will happen less and less often, and they will be of smaller amplitude. Passive investing will probably no longer be that easy.