US inflation is now sitting at 5%. That’s much higher than analysts had expected. It’s the fastest rate since before the global financial crisis.
More importantly, if you look beyond the headline measure, inflation hasn’t been this high in nearly 30 years.
So is all of this really transitory? Do central banks really care if it is or it isn’t? And either way, what does it mean for you and your money?
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US inflation isn’t looking as transitory as it did
Inflation is the big story on everyone’s minds right now. And yesterday we got our latest fix of price data from the world’s most important economy.
It turns out that in May, core consumer price index inflation hit a 28-year high of 3.8%. In other words, prices – even excluding the more volatile stuff like food and energy – were up nearly 4% on where they were in May 2020.
No big deal surely? After all, last year half of the economy was shut. It’s all about everyone getting out of the house and spending money in a sudden surge. So surely it’s “transitory”, to quote the Federal Reserve’s favourite word?
Well, that story is getting increasingly hard to stick to. Yes, a lot of the surge is being driven by those sectors most directly exposed to the rebound. Car rentals, used car prices, and the price of plane tickets were all up massively. Car rental prices were up 12.1% on the month, never mind the year.
Yet even if you assume that those price jumps will eventually even out (which is an assumption, not a guarantee) and cut them out of the data, prices elsewhere are rising too.
As Andrew Hunter of Capital Economics points out, “there were also signs of emerging inflationary pressures in other sectors, including housing costs and restaurant prices, which suggests that not all the current upward pressure on inflation will prove transitory.”
Investment bank ING echoes the point. It expects inflation to edge lower during the third quarter of the year as “the economic extreme of lockdown is no longer included in the calculation.”
However, both ING and Capital think that the Federal Reserve, America’s central bank, is being overoptimistic in its ideas that consumer price inflation (CPI) will quickly drop back down to 2% and behave itself.
ING argues that stimulus is causing demand to rebound strongly. Supply, however, has been hit by pandemic-related “scarring”. As a result, “we are concerned that supply capacity won’t be able to cope with the scale of demand.”
Higher raw materials prices and shipping fees are driving up costs. The labour force has been disrupted too. In the US, unemployment benefits have improved and arguably have created a higher minimum wage. ING adds that the need for increased homeschooling has become a factor in pushing some parents to stay at home rather than go out to work.
So the cost of labour and the cost of goods is rising for companies. But because demand is high, the market will absorb price rises. According to a survey by the National Federation of Independent Businesses, says ING, plans to raise prices “are at their highest since 1980”.
Markets are happy to believe the Fed – for now
These statistics are striking, and in many ways heartening. It’s good to see a strong rebound; it’s good to see wages going up. But clearly, this all has consequences in an economy and for a market that’s been used to non-stop disinflation for the last 40 years or so.
Let’s assume that inflation does remain high-ish. The thing that will worry investors most for now is the idea that higher inflation will push the Fed to raise interest rates earlier than otherwise expected.
From that point of view, the market reaction yesterday was interesting, in that not very much happened. The Nasdaq – which is arguably the most interest-rate sensitive stockmarket – was unfazed. The price of ten-year US Treasury bonds actually rose (and thus the yield fell) a bit. Gold was a little bit higher but nothing spectacular.
This all suggests that however markets interpreted this latest piece of data, it was “priced in”. It feels like markets panicked a bit about inflation earlier in the year. Now that’s a bit out of their system.
They’ve bought the idea that it’s transitory. Probably more importantly, they’ve basically bought the idea that the Fed will treat it as though it’s transitory as well.
I suspect they’re right on the latter. I don’t think the Fed will be keen to do anything other than talk about talking about raising interest rates. There is no desire to scare the horses.
On the former – I’m not so sure. I think inflation will continue to come in “stronger than expected” and I also think it will come in stronger than the market has already priced in. There will come a point in markets when investors might start to think: wait a minute, inflation at this level, and bond yields at that level, simply don’t add up.
For now we’re still in Goldilocks territory. But I’m hanging on to gold.
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