The big question today in the markets is about inflation. If inflation is real and prices on goods and services are rising, then the Federal Reserve (Fed) will back off its accommodative stance and interest rates will rise. Rising interest rates generally pressure stock prices to some degree as bonds with higher yields become an attractive investment alternative for some investors who want less risk and a higher yield.

Approximately two weeks ago the U.S. Bureau of Labor Statistics released its monthly report on inflation revealing that the headline Consumer Price Index (CPI) rose 0.8% month over month and 4.2% year over year, well above expectations. Core CPI, which strips out volatile food and energy, rose 0.9% month over month, its highest reading since the early 1980s, and 3.0% year over year, again well above what analysts thought. As a result, stocks had one of their worst days in months over fears higher inflation could mean the Fed will be forced to hike interest rates sooner.

NOW, THE GOOD NEWS. The Fed and LPL Research believe that these sudden spikes in inflation numbers to be transitory. The reopening of the economy is happening, and supply chain issues are making it harder to get goods. Some jobs are difficult to fill, and massive stimulus has created high savings levels and all this has caused price pressures to build. But once the reopening has taken place and these bottlenecks have cleared, LPL expects inflation readings to come back down. The Fed agrees, having said for months that any higher inflation numbers will be transitory, which means things should go back to normal once we get past the shock of reopening.

THERE IS MORE GOOD NEWS. The U.S. economic recovery is now in full swing. As a result of strides toward full reopening, rapid vaccine distribution, massive stimulus efforts, and support from the Fed, LPL Research recently upgraded their 2021 forecast for U.S. Gross Domestic Product (CPI) growth to 6.25% – 6.75%. This is more than double the expectations at the start of the quarter, and it is clear the economy is humming along. Last year’s 3.5% drop in GDP, the worst since the great depression, is a thing of the past.

Because the recession last year was likely the shortest ever (besting the six – month recession in the early 1980s) and the economy was supported by historic stimulus, some imbalances weren’t worked off like we tend to see in a normal recession. Corporate debt levels remain high, supported by low interest rates, and stock valuations never really reset. The good news is this new cycle of growth has enough going for it to be at least average, and even that would mean it still has another four years of economic growth left. There’s nothing wrong with being average!  – Mark.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. No strategy assures success or protects against loss. Economic forecasts may not develop as predicted. Some of this research material has been prepared by LPL Financial. All indices are unmanaged and may not be invested into directly. Referenced material: LPL Research Weekly Market Commentary dated, 5/17/21. Approved Tracking #:  1-05148251.