Analyst: Consumers Should Expect Serious Inflation

John Taylor was right about inflation.

During a February 2010 speech to members of the Greater Fort Smith Homebuilders Association, Taylor said the near term economic picture will include higher commodity prices, continued unemployment woes, inflation and “radically higher interest rates.”

Taylor, senior vice president of John Taylor Financial-Sterne Agee and a member of the board of directors at Fort Smith-based Benefit Bank, said at the time that rising federal deficits and Federal Reserve policy of injecting money into the economy would result in higher prices.

The February Consumer Price Index — as reported by the U.S. Bureau of Labor Statistics —  found that during past 12 months, the index for food at home has risen 2.8% and the index for food away from home rose 0.2% percent in and has risen 1.6% over the past 12 months. Also, the 11% increase in the energy index is the largest since May 2010, and the 2.3% rise in the food index is the largest since May 2009. (The March index is scheduled for an April 15 release.)

FOOD, RETAIL PRICES


Bill Simon, the CEO of Wal-Mart U.S., made news last week when he told the USA TODAY editorial board that inflation is “going to be serious” in the next few months.

"We’re seeing cost increases starting to come through at a pretty rapid rate,” he told the board.

In that same USA TODAY story, retail strategist John Long said higher Chinese labor costs and higher energy prices will result in higher retail prices by June.

The U.S. Department of Agriculture predicts all food costs will rise within a 3% to 4% range in 2011. In the prediction, poultry prices will increase 2.5%-3.5%, beef and veal prices may rise as high as 5.5%, processed fruits and vegetable prices may rise 3%-4% and cereals and baked goods prices could rise 4.5%.

The National Inflation Association, a fiscally conservative outfit that believes the federal price index reports are lower than reality, predicts higher price increases.

“An increase in year-over-year CPI growth from 1.1% in November of last year to 2.11% in February of this year means that the CPI’s growth rate increased by approximately 92% over a period of just three months. … Even if the BLS manages to artificially hold the CPI down around 5% or 6%, NIA believes the real rate of price inflation will still rise into the double-digits within the next year,” the NIA noted in its “12 Warning Signs of U.S. Hyperinflation” report.

‘TRANSITORY’ AND TRANSPARENT INFLATION


Federal Reserve Chairman Ben Bernanke in a recent speech downplayed inflation concerns.

“I think my take on inflation right now is that we are indeed seeing some increases, obviously,” Bernanke said.

Bernanke cited short-term international supply and demand issues for recent inflation pressures, and believes those issues will “stabilize.” He said the “increase in inflation will be transitory.”

Taylor is not as confident as Bernanke that inflation will moderate. Also, he says inflation has found ways to impact the consumer in a way the government doesn’t always capture.

“What we see is that packaging is shrinking. The examples are the smaller soap bars in the same boxes, and you get less chips in the same size bag, and that’s all at the same price. … That’s inflation people don’t see, unless they are really price conscious about what they are buying,” Taylor explained.

ANOTHER RECESSION?


The other problem with inflation is it could further curtail consumer spending, which is the driver of the national economy. (Consumer spending represents between 40% and 70%, depending on the numbers one chooses to accept, of U.S. GDP.)

“It absolutely does create the possibility of a return to a recession,” Taylor said, adding that consumers will face rising inflation, lower home values and increases in mortgage rates. “I think we are very much in risk for a double-dip recession. I know nobody wants to hear that, but it could easily happen. … The consumer is not back to the (economic recovery) party anyway, and now you throw this inflation in.”

Most consumer interest rates declined between February 2010 and September 2010, but since October, they have jumped. For example, a 30-year fixed-rate mortgage was around 3.9% in the fall, but is now up to about 5% and trends suggest continued increases.

INFLATION PREP


How should the average person prepare for inflation?

Taylor encourages anyone with debt tied to a floating interest rate to soon convert the debt to a fixed-rate interest. For those with money to invest, Taylor advises to not buy long-term instruments. For example, if a bank teases with a higher rate on a 24-month CD, the buyer may find that 12 months later that interest rates have moved past the locked-in 24-month rate.

“I would avoid, or be very careful about the longer-term maturities in this rising rate environment,” Taylor said.

Michael Tilley with our content partner, The City Wire, is the author of this report. You can reach him by e-mail at [email protected].