“Inflation is when you pay fifteen dollars for the ten-dollar haircut you used to get for five dollars when you had hair”

-       Sam Ewing

My local barber is an old school destination – no reservations or call ahead availability, cash only, and $20 for however much (or little) hair you want trimmed.  While this is a bit higher than the $5 cuts of yore, it has been that price for the last ten years and my wife marvels at the fact that a men’s haircut is only $20.  While everybody likes to reminisce about how things used to be cheaper - whether it was gas for $1.00 a gallon, fifty cents for a gallon of milk, or a ’69 Chevy Camaro for $4,000 – inflation is an inexorable trend that consumers and investors must consider closely as it plays a significant role in the economic outlook.

In particular, the interest rate policy of the Federal Reserve is closely tied to inflation as the Fed’s dual mandate requires them to promote both a healthy job market and stable prices for consumers.  When inflation gets out of control, the negative impact on consumers is severe and the Fed is forced to hike rates.  Think of the 1970s when inflation spiked and the Federal Reserve raised rates from 4% to over 10%.  More recently, the Fed has started to raise rates from zero to 2.5%, as the economy has started to grow and inflation has picked up slightly.  Yet with interest rates above zero, growth starting to decelerate, and inflation remaining tame, many have questioned why the Fed needs to fight inflation with further rate hikes.  Particularly if areas of the economy that are showing signs of heating up are resulting in “good” inflation rather than “bad” inflation.

Source: Independent Financial Partners

Source: Independent Financial Partners

For instance, one statistic that is showing consistent signs of “good” inflationary growth is that of wages.  According to the Bureau of Labor Statistics, average hourly earnings are up 3.5% from a year ago.  This is the fastest growth rate in earnings during this cycle, and well above the average annualized growth rate of 2.3%.  Perhaps this data point is inflationary, but is it a problem if consumers are earning more money and is it something that the Federal Reserve should tighten the reins on?  In our view, no, it is a healthy type of inflation.  If it eventually leads to a broad uptick in prices for goods and services, then the Fed can tighten rates in response at that point in time, rather than trying to pre-empt it.

What about other areas of the economy?  Gas prices, a metric that might be thought of as “bad” inflation currently, averages $2.42 a gallon.  This is below their recent average price of $2.88. 

Source: Independent Financial Partners

Source: Independent Financial Partners

The Consumer Price Index (CPI), a broad measure of inflation that looks at price changes in areas such as energy, housing, and healthcare, rose just 1.6% on an annualized basis in its most recent reading.  This is also well below the historic annual inflation rate of 4.0%.  House prices are one area that have seen pretty strong ‘inflationary’ growth, with the most recent Case-Shiller Home Price Index showing a national price increase of 4.7%, over the last year.  However, this brings us back to our point about wages: if the parts of the economy experiencing an upward move in inflation are resulting in bigger paychecks and a greater sense of wealth (what we would call “good” inflation), why would the Fed try to undercut this momentum by continuing to raise rates?

The Fed seems to be acknowledging this, with Chairman Powell noting recently that “given muted inflation pressures, the [Fed] has adopted a patient, wait-and-see approach to considering any alteration in the stance of policy.’’  In essence, the Fed is saying that unless inflation shows a prolonged spike higher, we can expect interest rate policy to be hold for the foreseeable future.  In our mind, this is positive for the economy as it signals that monetary conditions, while tighter than they were a year ago, will remain fairly accommodative and supportive of markets.  A little inflation is not bad for economic growth, especially when it is the kind of inflation that improves ones sense of wealth. 











Investment advisory services offered through Independent Financial Partners, a Registered Investment Adviser

WhartonHill Investment Advisory is not owned or controlled by Independent Financial Partners

The opinions voiced in this material are for general information only and are not intended to provide specific investment advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.

 All data via Bureau of Labor Statistics, the Federal Reserve, and charts via Independent Financial Partners