Why people are getting the inflation debate wrong: Charles Schwab's Liz Ann Sonders

Inflation expectations are picking up as bond yields (^FVX, ^TNX, ^TYX) surge higher Tuesday and the reopening trade kicks back into high gear. As the debate heats up over whether these signs of price inflation are transitory or not, one prominent Wall Street strategist provides some context and warns not to view inflation too simplistically.

At a recent Yahoo Finance Plus webinar, Liz Ann Sonders, chief investment strategist at Charles Schwab, broke down the dynamics of inflation, beginning with the observation that “transitory” simply means “not permanent.” She quipped, “[B]y that definition, one could argue even the inflation of the 70s into the early 80s was transitory. So some of it is [a] function of timeframe.”

Price inflation is typically measured sequentially (month-to-month) and annually (year-over-year), with the latter introducing what are known as base effects. As Yahoo Finance’s Brian Cheung explained in a recent Yahoo U, base effects “refer to the impact of comparing current price levels in a given month against price levels in the same month a year ago.” 

But observers of this data require context to understand the relative importance of these numbers. Whether or not price inflation levels were already elevated or depressed a year ago adds such context. Back in March, April and May of this year, inflation was compared to the disinflationary levels in the corresponding period of 2020. 

But Sonders says those base effects are largely in the rearview mirror as companies fix their supply chain disruptions. However, it depends on the category of goods and services measured, as some imbalances remain. “[I]t really is a function of what service or commodity product you’re talking about. I think some of those imbalances are probably stickier in nature, not least being semiconductors,” she said.

Lumber liquidated

Sonders says the extreme price swings of lumber is a good example of why it’s more helpful to dig into the different categories and segments of price inflation. “[Y]ou saw the parabolic move up in lumber. That wasn’t really a shortage of lumber, it was actually a shortage of drivers to get the lumber from where it resided to where it was needed. That’s easy. And we’ve seen a 70% decline in lumber prices since then. So I really think you almost have to go segment by segment.”

Lumber's wild ride

Lumber’s wild ride

She also notes the easing of auto and rental price pressures in the latest CPI data. “[New car prices] had been a big source of upward pressure on CPI medium to longer term. I think there are two key things… in the case of CPI, the rent component — the combination of actual rents and owners equivalent rent — account for more than 40% [of the total price increases]… So that’s really what we want to watch to see whether it’s starting to abate longer term,” says Sonders.

Psychology of inflation

Price inflation is not sustainable if people can’t afford the prices and companies don’t have pricing power. But that changes as workers’ wages increase, and it’s a so-called wage-price spiral that can really get prices cranking to the upside.

Sonders explains that it’s important to look for signs when purchasers’ and workers’ psychology is changing.

“When you go through real serious periods of inflation, like in the 1970s, it had a lot to do with the psychology — the psychology of workers willing to ask for higher wages … [and] companies’ willingness to pass on higher costs. And there’s a psychological aspect to that which is harder to quantify, but something that we have to keep in mind as we think about the longer term implications of what we’re seeing right now,” says Sonders.

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Jared Blikre is an anchor and reporter focused on the markets on Yahoo Finance Live. Follow him @SPYJared

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Harry Byrne

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