Financial markets were already skittish about inflation when the government reported that consumer prices in April rose 4.2% from a year earlier. (https://www.wsj.com/…) The report sent stocks reeling further.
The Federal Reserve has been saying for months that it expects inflation to accelerate this year. The Fed thinks the increase will be temporary. The question is, how long is temporary?
The longer it goes on, the greater the chance the Fed will be forced to do what it says it doesn't want to do: raise interest rates.
In remarks prepared before the report, Richard Clarida, the Fed's vice chairman, said, "These one-time increases in prices are likely to have only transitory effects on underlying inflation, and I expect inflation to return to -- or perhaps run somewhat above -- our 2% longer-run goal in 2022 and 2023." (https://www.wsj.com/…)
A year earlier, as the pandemic shutdowns began, prices of many goods and services collapsed. This lowered the price base and made last month's increase look larger.
Still, it's clear that the economy is rebounding, boosting demand for almost everything at a time when supply is still challenged. That's a recipe for inflation, and it's unclear how long it will take for supply and demand to reach equilibrium.
The best place to look for clues will be the bond market. Bond investors are super-sensitive to inflation. Inflation by definition renders currencies less valuable. No lender wants to be repaid in devalued dollars.
Inflation fears, then, tend to lower bond prices, which raises bond yields. Should that happen in the months ahead, the Fed could eventually be forced to raise its benchmark interest rates.
Farmers and ranchers who borrow operating money have enjoyed a prolonged period of low rates with assurances from the Fed that low rates will continue. If consumer prices continue to soar in the months ahead, those assurances could be at risk.
Urban Lehner can be reached at firstname.lastname@example.org
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