What do booking a trip, filling your gas tank, building a house, eating out and purchasing groceries all have in common? They're all getting more expensive — in some cases, quite a bit.
Rising prices are a reality for many of the goods and services we consume, with some increases so sharp they’re giving consumers a bit of sticker shock. The price of a used vehicle, for example, rose 29 percent year-over-year in May. Gas prices are up 28 percent. And when we get rising prices, economists, journalists, and policymakers take note as “inflation” becomes a key issue of debate.
And if you’re planning a big purchase, such as a car or new house, it can feel like you’re stuck in a catch-22 while the inflation debate carries on. Is it better to wait for prices to fall, or should you lock in prices today in case they keep going higher?
While no one is absolutely sure what will happen to prices in the future, understanding what’s driving today’s rising prices can help as you weigh your decision to take action or wait.
RISING PRICES ARE A RESULT OF SUPPLY CONSTRAINTS
The 2021 inflation story line had been dominated by rising prices for lumber, as costs for timber exploded from pandemic lows. But lumber also vividly reveals the impact of supply constraints, which is a key driver of rising prices across industries coming out of the pandemic.
On April 1, 2020, lumber cost $259 per 1,000 board feet. In May 2021, that price hit $1,711, an all-time high. Housing demand remained robust through the pandemic, but lumber mills were forced to shut down or operate at limited capacity. As restrictions lifted, mills couldn’t keep up with demand and lumber prices rose sharply.
Here’s the thing, the largest lumber companies in America aren’t in a rush to build more sawmills to catch up with capacity. The implication here is that lumber managers aren’t convinced high prices will stick around long enough to justify spending big bucks and several years to build new mills. In other words, these high prices appear transitory. And lumber managers' instincts seem to be correct: Lumber prices fell well below $1,000 in June.
We’re seeing supply constraints push prices higher in other areas, as well. Used vehicle prices are being driven higher by a global semiconductor shortage that’s halting production of some new vehicles. Shipping disruptions (remember that ship that got stuck in the Suez Canal?) and weather-related incidences (winter storms in Texas), have also made it difficult for companies to build and ship anything from vinegar to IKEA furniture.
An ongoing labor shortage is also making it hard for businesses to hire enough workers across industries to up productivity. That will either limit supply, or companies will raise wages and pass those costs onto consumers. These various supply hurdles, all happening at roughly the same time, are putting some upward pressure on prices. But, as we've seen with lumber, prices can quickly fall back to earth once the market balances.
BASE EFFECTS MAGNIFY THE INFLATION STORY
Another factor to consider is base effects from year-over-year comparisons. The economy shut down in an unprecedented manner last year, leading to a historic, swift decline in economic growth. As we “lap” those pandemic-driven lows, some of the economic data is going to look far more dramatic than we’re used to.
Gas prices are a good example. When the world shut down last year, consumption of energy dropped off a cliff. So much so, oil prices fell into negative territory briefly in 2020. Consumers certainly got a nice break at the pump last year, but prices have risen sharply since. Gas prices were up roughly 30 percent year-over-year in May. And while that may seem like an astounding leap in prices, gas prices have simply recovered to levels last seen in 2019.
PUTTING IT ALL TOGETHER: RISING PRICES MAY BE TEMPORARY
In a nutshell, inflation is all about too many dollars chasing too few goods and services. That’s essentially what’s happening today. The U.S., by and large, is reopening and consumers with savings and pent-up demand are spending on the things they enjoyed and missed dearly during the pandemic. Businesses, on the other hand, are battling a perfect storm of obstacles trying to keep up.
As the economy gets moving and inventories normalize, there’s a good chance prices will moderate. That’s the position the Federal Reserve is taking thus far, and there’s some evidence that’s already happening. Lumber prices are already down more than 40 percent from their highs earlier this year. Kids are returning to school and enhanced unemployment benefits are expiring in many states, which should help employers fill open positions to satisfy customer demand.
One concern when inflation rises is that consumers all pile in to buy a product before prices go higher — effectively raising prices further. Instead, data show prices are top of mind for consumers, particularly for big ticket items like cars. Data suggest those consumers may pare back purchases or delay them. Because consumers are being price aware, it could provide time for businesses to replenish inventories after an unprecedented year of supply disruptions.
And, for most of goods we consume, inflation has been a more modest 2 percent. That’s according to the Cleveland Fed’s median CPA measure, which trims outliers in the data to see how much prices have risen on most goods. Two percent is the moderate sweet spot where the Fed wants inflation. So, stripped of some exceptional outliers, inflation isn’t as hot as the headlines may suggest.
If you’re thinking about a big purchase today, keep some of these factors in mind. Prices are indeed rising, but they may moderate in the intermediate term.
The opinions expressed are those of Northwestern Mutual as of the date stated on this material and are subject to change. There is no guarantee that the forecasts made will come to pass. This material does not constitute investment advice and is not intended as an endorsement of any investment or security.