April inflation prints in the US, Europe and many other emerging markets caught many investors unaware. But before you rush to rebalance portfolios, it is important to satisfy yourself on whether these numbers are transitory or persistent. In some emerging countries such as Turkey and Brazil, inflation may have staying power if not tamed. However, in most developed markets we see a lot of temporary factors driving April numbers: pent-up demand, supply bottlenecks, wealth effect, base effect and easy policy frameworks. But again, transitory inflation can flare up becoming a long-term problem so investors should remain vigilant.
The US housing market gives us an insight into the drivers of US inflation. American homes are becoming expensive, thanks to the pandemic. Working from home and low mortgage costs seem to be persuading city dwellers to consider moving into suburbs, which is pushing up house prices. House prices popped 13.2% in March compared to the prior year. The graph below illustrates the surge in US house prices using the Case-Shiller National Home Price Index. [based on a constant level of data on properties that have undergone at least two arm’s length transactions]
But temporary factors are observable. The Fed which continues to reiterate its accommodative posture well into 2023, has propped demand. The wealth effect because of inflated financial asset valuations is also seeing some cashing out their portfolios and investing in real assets. Supply, on the other hand, is constrained. Home suppliers are experiencing swelling costs in land, labour, and building materials, including lumber (up 282% in one year to 2 June 2021). These dynamics are fueling inflation in this sector, but we do not think the drivers are sustainable hence our leaning towards the view of transitory inflation.