Inflation has been pretty non-existent over the last few years, but lately it’s showing signs of life. The Fed targets a level of 2% for “core” inflation, and the latest reading from September 2016 was 2.21%.
Simply put, inflation is a general increase in prices and a fall in the purchasing value of the dollar. The U.S. Core Inflation rate is the Fed’s primary benchmark for inflation, and it excludes food and energy costs. These are considered too cyclical and volatile to be core components.
Long-term inflation expectations are on the rise too. According to Tradeweb, expectations are around 1.74% over the next 10 years, much higher than the 2016 low of 1.19%.
Obviously these expectations are still below the Fed’s 2% target, so it highlights the fact that investors are still skeptical that we’ve kicked the low-inflation problem.
People often view inflation in a negative light, and this is partly the financial media’s doing. And I get it, nobody is crazy about the prospect of paying more for basic necessities like food, clothing, etc. But inflation is actually a good thing if kept under control.
It means that the economy is improving, and real assets, like real estate, are increasing in value. With some inflation, companies are able to increase product prices, and real wages are hopefully rising. And yes, it does mean that interest rates will actually rise someday.
The Fed’s primary mechanism for keeping inflation in check, is to raise interest rates. They have to see marked economic improvement and signs of price increases to justify raising rates.
The Fed has tiptoed back into raising rates, so hopefully we’re on our way back to a more normalized economic environment.
Source: Bureau of Labor Statistics, WSJ