In my April Newsletter, I indicated that there were some potential problems with the economy. In particular, I suggested inflation might get ahead of the FED. The other concern I had was the lack of a sufficient supply of microchips.
Both of these bore out in the second quarter. The inflation rate, Consumer Price Index (CPI) rose in June to 5.4%, year over year. The targeted rate for inflation desired by the FED is 2%. This increase in inflation is worrying investors. It has led to a decrease in stock prices and an increase in the purchase of bonds, which are safer than stocks.
The inflation rate has jumped up primarily because of an increase in energy prices and used car pricing. The automobile industry has a severe problem with a shortage of computer- chips. Ford Motor Co. said that due to the computer-chip shortage they were either reducing production or eliminating the production of several popular vehicles. Ford is now giving priority to thousands of vehicles that it has assembled in recent months but parked in lots near factories as it awaits needed computer chips. This has led to two inflationary issues: a rise in new car prices of about 5% and an increase in used car prices of about 10.5%.
At the beginning of 2021, the price of a barrel of oil was 48.52. At the beginning of July, it was 73.47, up 52% since the beginning of the year. This has occurred because OPEC has chosen to reduce output even as the demand has accelerated, as we come out of the pandemic.
Will Inflation Subside?
The question is: will inflation be a long-term issue or one that has occurred as supply chains were disrupted during the pandemic? It appears that OPEC has decided to increase production, which should alleviate some of the pressure on gas prices. In addition, the price of oil is so high many fracking operators can make money again on oil. The economy is shifting away from fossil fuels, which may reduce demand over time. It, therefore, doesn’t appear that energy will continue its torrid price increase, as some expected.
New car prices should stabilize as micro-chips become available and this, in turn, should have a negative impact on the price of used cars.
During this past quarter, a Congressional bi-partisan group worked with the President to put together the outline of an infrastructure spending plan. This plan could have a major impact on the U.S. economy going forward. Unfortunately, it is not clear that the partisan infighting that is taking place will allow this to happen. It appears clear to most people that this investment is needed. We will see what unfolds over the course of the year.
Bond Pricing Impact
As noted earlier, investors have moved more money into bonds and out of stocks recently. When the demand for bonds is greater the prices go up and the yield, interest rate, goes down. This is what has been happening. At the end of the last quarter, the 10-year Treasury Note had a yield of 1.749. At the end of June, the yield was 1.443% for an increase in value of about 2.2%, for the quarter. This is meaningful because many loan rates are tied to the 10-year Treasury rate, including mortgages and car loans. When the interest rate on the 10-year Treasury goes down, as it did in the quarter, then many other loan rates do the same.
The S&P 500 ended the quarter at 4298, up 8.1%. The S&P MidCap index closed at 2696, up 3.3% for the quarter. The S&P Small Cap index closed at 1375 up 4.3% for the quarter. The MSCI ex USA index for foreign stocks rose from 336 to 352 for an increase of 4.76%. As noted earlier the 10-year Treasury rose from 1.749% to 1.443%, while the Bloomberg Barclays US Aggregate Bond Index yield went from 1.61% to 1.50%, also a rise in the value of those bonds.
What can be seen in the U.S. economy is that the pace of growth that we saw in the first quarter slowed down in the second quarter. It appears that all the pandemic spending by the government kick-started the economy and now we are moving into a more normal growth phase. It appears that as more businesses get back to normal the shortages of some supplies, like lumber, are also ending. This may bode well for a reduction in inflation. The shortage of employees in some sectors may change when the extra $300 per week unemployment bonus ceases in all states. This in turn will likely reduce the unemployment rate.
1Markets Digest, Wall Street Journal, July 1, 2021
2Amadeo, Kimberly, “What Is the Current US Inflation Rate?”, www.thebalance.com, July 17, 2021.
3Business & Finance, Wall Street Journal, July 1, 2021