Rapid Inflation in 2018, Many Catalysts

With the Trump administration initiating the implementation of tariffs on steel and aluminum, should market participants be worried about inflation?

Well with a trade war looming, inflation will definitely be in the pipeline as when competition is squeezed, naturally, prices tend to rise. The approaching trade war is only one of many headwinds facing inflation in 2018.

With a mix of fiscal stimulus, global growth and the feds anticipated rate hike, one can only imagine that inflation is guaranteed. Let’s examine why:

Wage Growth Pressure

We are currently experiencing a labor shortage in small companies within the United States. These small businesses are considered the meat of the economy as they tend to do most of the hiring.  Of course, when a certain group is in demand, companies tend to get into a bidding war by paying them more. A survey conducted by the National Federation of Independent Business revealed that the number of small companies planning to raise pay is at the highest level in decades.

Fiscal Stimulus

Lawmakers have recently agreed to increase federal spending by 300 billion over the next two years. On the other hand, US recently slashed taxes. Joe Lupton, a senior global economist at J.P. Morgan, recently predicted that unemployment will fall to around 3% in 2019.  If that prediction comes true, companies will be bidding higher and higher wages.

Rising Commodity Prices

Since the US dollar is experiencing prolonged weakness (in the last 12 months, the US dollar index has dropped 10%) commodities will continue to climb as they are priced in dollars.  Keep in mind when the US dollar goes down, demand increases as commodities become cheaper. The S&P GSCI commodity index is up 25% since last summer.

Are Equities The Answer?

To an extent, equities can enact as an inflation hedge as all the indices are priced in nominal dollars which is not inflation-adjusted real dollars.  Companies have the ability to increase prices for consumers to maintain profit margins.  Historically, stocks tend to overshoot inflation at the end of the stock market cycle due to a lack of suitable investment alternatives.