Glassman Wealth Services LLC

Every few months, inflation or deflation resurfaces as the featured topic of discussion. There seems to be an even divide of individuals who believe inflation is a foregone conclusion and those who feel deflation may actually be the bigger concern. Both outcomes are relevant in their own right, but there are growing signs that hidden inflation is creeping into the American economy.

For example, in the month of January, consumer prices rose 0.2%. That came after little or no increase to CPI from October through December. By most accounts, inflation is far tamer than earlier in the post-recession period.

By other accounts, however, inflation is at the start of a pernicious cycle. The Federal Reserve Bank of Cleveland looks at median CPI, which provides a more accurate assessment of underlying inflation trends. Median CPI is approximately 50% more accurate than CPI and 25% more accurate than core CPI.

Based on the Cleveland Fed’s analysis, median CPI rose 0.2% in January, following identical 0.2% gains in each of the previous four months. In fact, median CPI has gradually trended higher for the better part of the past 18 months. Over the past 12 months, median CPI is up 2.4%, the highest reading since early 2009.

Higher Prices and Stagnant Wages

A critical component of the inflation picture remains unsolved: wages. With the unemployment rate still stubbornly high at 8.3%, and every ounce of productivity being squeezed from those who are employed, there is little room to negotiate higher salaries.

At the same time, Americans are likely paying the most attention to what they are spending at the pump. Retail gas prices are at the highest level ever for this time of year. Nationally, prices are at $3.53 per gallon and $4 gas is expected by summertime. According to some economists, a 25-cent per gallon increase costs the economy and consumers some $35 billion.

Gasoline is certainly not the only input into the cost of everyday living, but it is one of the most noticeable and prevalent for consumers. Concerns about the evolving situation in Iran only enhance fears that prices could skyrocket at a moment’s notice.

Banks/High Unemployment Keeping Inflation in Check for Now

Inflation has long been a fear of economists given its “sticky” and stubborn unwillingness to retreat once achieved. Those fears were only heightened once the Federal Reserve began a radical expansion of its balance sheet to prop up banks and other struggling institutions.

Thus far, those measures have aided the firms in need, but largely remained trapped within those echelons and unable to find their way into the broader economy. If, and when, banks and other financial institutions deem it timely to begin lending en masse, we will see a quick shift in inflationary dynamics.

That event is viewed as being far away, but with the economy improving, and inflation returning to many segments of the economy, banks may be the next frontier.

Investors should pay close attention to what the banks do next, as they hold the key to any future inflation. For now, inflation is not ready to fully reveal its presence given high unemployment and only moderate economic growth, but do not be surprised if prices accelerate over the next few quarters.

As financial advisors, we look at a broad range of market and economic forces to form our investment decisions. In our monthly economic report, we take a look at the effects these forces have had on markets nationally and globally during the month. This broader perspective helps us to provide more insightful investment and financial planning advice to our clients. Click Here for report.

Consumers are an integral cog in the American economic engine, but since the financial crisis hit its crescendo, consumers have been under high attack. By most traditional measures, the economy is larger today than any time in our history, but it is hard to argue that consumers are feeling the benefits of that expansion. That said, consumers seem to be taking a new view on debt and spending, all in the name of prudence.

With the benefit of hindsight, virtually everyone can agree that consumers came through the mid-2000s with too much debt, and too little concern about how to pay that debt. Measures such as the household debt service ratio, which measures debt payments on mortgage and consumer debt, reached record highs, nearly hitting 14% in the third quarter of 2007. The good news is that those figures have actually fallen faster than they rose.

Since 2008, the debt service ratio has fallen nearly 3 percentage points and stands at levels last seen in the mid-1990s.

As consumers started to feel mildly better about the economic outlook and about their personal financial situations, they naturally began spending more money.

Throughout 2011, for instance, consumer spending posted a 2.2% gain, after rising a similar 2.0% in 2010. However, those gains are largely coming from a drawdown in savings as opposed to wage growth. After peaking at above 7%, the personal savings rate has steadily declined over the past two years and fell as low as 3.5% in November before a slight rebound in December.

One of the primary reasons consumers have been reticent to spend has been a simple lack of sustained wage growth. In recent months, wages have bounced around in a volatile fashion, falling over the summer, before jumping in the fall and weakening again as winter approached.

Consumers have at least one reason to be optimistic. Labor markets are inching toward definitive improvement for the first time since the recession ended. Initial claims for unemployment benefits have consistently tracked below 400,000 since early November, the longest such period since mid-2008.

Consumers are in better shape than 2007-08, be it from “strategic defaults” or through intentional efforts to act responsibly, but there remains a long way to go to reignite such a vital cog. The good news is that labor markets are gradually thawing, and such improvement should lead to higher wages and better employment prospects.