Beware: inflation is starting to stir in the US

With US consumer prices up by 1.4% in the last year, concern about inflation is now everywhere.

Investors are pencilling in higher inflation. US inflation expectations, as measured by the ten-year breakeven rate (the gap between the yield on the ten-year Treasury bond and the rate on its inflation-linked counterpart) recently went above 2% for the first time since 2018, says John Detrixhe for Quartz. That’s “not exactly Argentina-style hyperinflation”, but it marks a big increase since last March, when the breakeven rate slumped to 0.5%.  

An inflationary spring 

Renewed lockdowns mean that inflation remains subdued for the time being. The annual rate of consumer price inflation in the UK (CPI) is just 0.6%. In America consumer prices rose by 1.4% last month on a year before. 

Nevertheless, concern about inflation is now apparent everywhere, from the bond market to business surveys, says Neil Irwin in The New York Times. The inflation numbers are bound to spike higher this spring because of statistical effects. Prices plunged when Covid-19 struck last year, so prices returning to normal will register as an inflationary leap in the year-on-year comparison. 

We are also likely to see sector-specific price surges. If everyone comes out of Covid-19 “hibernation” at once there won’t be enough restaurant tables and hotel rooms to go around, driving price hikes.

Some say an inflation spike will mark the start of a new trend. Advocates of that view point to structural changes in the economy, says Roger Bootle in The Daily Telegraph. Deglobalisation and an ageing population in major economies could shrink the available supply of labour over the coming decades. 

Yet in the near-term, inflation will be driven by the demand side of the economy. 2020 delivered a “veritable explosion of the money supply”, with the UK M4 gauge of the money supply soaring by 13% over the past year. In the US M2 money supply has increased by 24%, a figure that would have sent 1980s monetarists into a “flat spin”. 

Don’t count on the central bank 

That money has found its way into the pockets of consumers, says Irwin. Between March and November Americans saved a staggering $1.56trn more than they did in the same period a year before. It won’t be long before that cash starts to leak out into the real economy. “When a bathtub is filled to the very top, it doesn’t take much sloshing for it to spill out on the floor.” 

A few years ago, investors would have said that if inflation spikes, then central bankers would raise interest rates, preventing a more durable take-off , says Gillian Tett in the Financial Times. 

Yet those old certainties have started to wobble. America’s Federal Reserve has already indicated that it is relaxed about inflation passing above the 2% target, just so long as it averages 2% over several years. 

The vast debt loads that governments have accumulated fighting the virus also make raising interest rates politically difficult. Buckle up, says Randall Forsyth in Barron’s. There are already signs of “supply tightness” emerging in markets “from DRAM chips to ... commodities” (see below). As policymakers fight today’s crisis, “tomorrow’s inflation starts to stir”.

Recommended

How to claim compensation for travel delays
Personal finance

How to claim compensation for travel delays

It promises to be a summer of chaos at airports, with thousands of flights cancelled and huge queues, while strikes on the railways haven't helped eit…
5 Jul 2022
Is it OK to buy Scottish Mortgage investment trust again?
Investment trusts

Is it OK to buy Scottish Mortgage investment trust again?

Scottish Mortgage investment was hit hard by the tech-stock crash, and it is still being buffeted by headwinds. Should new investors wait for those to…
5 Jul 2022
Britain’s ten most-hated shares – w/e 1 July
Stocks and shares

Britain’s ten most-hated shares – w/e 1 July

Rupert Hargreaves looks at Britain's ten most-hated shares, and what short-sellers are looking at now.
4 Jul 2022
Britain’s most-bought shares w/e 1 July
Stocks and shares

Britain’s most-bought shares w/e 1 July

A look at Britain’s most-bought shares in the week ending 1 July, providing an insight into how investors are thinking and where opportunities may lie…
4 Jul 2022

Most Popular

Ray Dalio’s shrewd $10bn bet on the collapse of European stocks
European stockmarkets

Ray Dalio’s shrewd $10bn bet on the collapse of European stocks

Ray Dalio’s Bridgewater hedge fund is putting its money on a collapse in European stocks. It’s likely to pay off, says Matthew Lynn.
3 Jul 2022
UK house prices are definitely cooling off – but are they heading for a fall?
House prices

UK house prices are definitely cooling off – but are they heading for a fall?

UK house prices hit a fresh high in June, but as interest rates start to rise, the market is cooling John Stepek assesses just how much of an effect h…
30 Jun 2022
Persimmon yields 12.3%, but can you trust the company to deliver?
Share tips

Persimmon yields 12.3%, but can you trust the company to deliver?

With a dividend yield of 12.3%, Persimmon looks like a highly attractive prospect for income investors. But that sort of yield can also indicate compa…
1 Jul 2022