The textbook response to recent economic data should be sharply higher interest rates.
An economy expanding at a 4 percent annual rate, like the American GDP did in the second quarter, would normally raise concerns of an economy on the cusp of overheating. The low unemployment rate would usually lead to quickly rising wages, fueling worries about an economy running at capacity.
Why the anguish over a strong economy?
One word: inflation.
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Inflation erodes the purchasing power of your money. That pay raise you got can be quickly eaten up by higher prices. For bond investors, rising inflation threatens to consume the cash coming in from the interest rate. Ideally, inflation follows the Goldilocks principle — not too hot, not to cold, just right.
The latest monthly inflation figures will be released on Friday in the week ahead. It may hit 3 percent for the first time in 6 1/2 years. The headline inflation number has been climbing for months, and it has picked up this summer thanks to higher energy prices. Even removing energy and food prices, inflation is as high as its been since the depths of the Great Recession. The yield on the 10-year Treasury bond is back near 3 percent, a seven-year high.
The general trend of higher prices reaches well beyond the gas station. Airfares and plastics can also feel the heat from higher energy prices. Procter and Gamble announced last week it is raising the price of Pampers, Bounty paper towels, Charmin toilet paper and Puffs tissues. Coca-Cola raised its prices calling it an “off-cycle” increase, blaming higher transportation costs and the American tariffs on foreign aluminum. Tariffs on Canadian lumber add costs to building new homes.
For years, the worry about inflation has been that there isn’t enough of it. While it remains historically low, investors should not forget about it.
Tom Hudson hosts “The Sunshine Economy” on WLRN-FM; @HudsonsView.