Prior to this year, plenty of investors knew about inflation. However, in 2021, investors are getting a crash course in varying types of inflation, namely persistent and transitory.

Clearly, the prevailing hope is that inflation will be transitory, but with the Consumer Price Index (CPI) residing above 5% for three straight months, the persistent camp has some ammunition for their argument. Of course, inflation, persistent or otherwise, has implications for a variety of asset classes.

“Inflation could derail the bull run for stocks by crowding out consumer spending and limiting the flexibility of the Federal Reserve to stimulate the economy. Fed Chair Jerome Powell has been remarkably successful in convincing both the stock and bond markets that the surge in inflation is transitory, though few know what ‘transitory’ means. The definition seems to adjust on the fly,” says Nationwide’s Mark Hackett.

As Hackett notes, the August CPI reading wasn’t all that discouraging to equity investors, and with the U.S. economy still dealing with the coronavirus pandemic, there is some historical precedent for the recent increases in the CPI.

“While inflation in August was elevated, investors were still encouraged by the monthly report, believing that the trend toward normalization is in place,” notes Hackett. “A deeper look at the data reinforces this belief. Prices in markets that were impacted heavily by COVID-19 remain elevated, including industries hit by supply chain disruptions and commodity cost pressures (e.g., gasoline and natural gas, new and used cars, apparel). Pressures in these areas may remain for the next several months, but are unlikely to persist indefinitely.”

High prices for energy commodities aren’t the just result of the reopening traded and elevated demand. When oil prices slumped last year at the onset of the pandemic, energy companies dialed back activity at some shale plays, and it takes some time to bring those rigs back online. Likewise, global supply chain issues caused by the pandemic are leading to chip shortages, inflating prices for an array of tech-dependent goods, including used cars.

Assuming forecasts prove accurate, inflation will ebb next year, but still remain above the Federal Reserve’s target.

“The current consensus estimate for calendar-year CPI is 4.1% in 2021, falling to 2.7% in 2022 and 2.4% in 2023. All three forecasts are above the Fed’s 2.0% target, but certainly manageable. As inflation expectations have moderated, so to have expectations for Fed rate hikes. The Fed Futures curve currently embeds a near-50% chance of no hike through 2022, up from 30% one year ago,” concludes Hackett.

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