Will All-Time High US Inflation Really Be Transitory?

As shown by the graph below, last week the US consumer price index (CPI) jumped to the highest level since the 2008 Financial Crisis, reaching 5.4% Year-on-Year (Y/Y), compared to the expected 4.9%. The Core reading showed the largest Y/Y increase since November 1991, coming out at 4.5% compared to the expected 4.0%.

US CPI 2008Due to the current circumstances, this rapid increase in inflation would not normally warrant the need to worry, as this is bound to happen due to a year of pent-up demand. However, there is worry, especially among leading economists such as Lawrence Summers, that the Fed has been extremely excessive in their  support and that, without monetary tightening, we may soon be heading to an overheating of the economy. 

As of now though, the insistence by the Fed that this high inflation is only transitory seems to be supported. Looking below at data from the US Bureau of Labour Statistics, we see that the main factors driving up inflation are energy prices and used cars (highlighted in red), which are commonly temporary factors caused by pent-up demand.

US CPI breakdown June 2021While transitory inflation is supported by the data as of now, markets do not seem to be completely sure. After the release of the CPI data, the Nasdaq 100 swiftly dropped over 125 points, due to fears of inflation being out of control and the prospect of monetary tightening, 2 hours later the Nasdaq 100 was back at all-time highs after reassurance by the Fed that inflation is only transitory.  

Although inflation seems to be transitory, this is not necessarily going to be true over the next few years without monetary tightening. There are signs of monetary tightening being discussed by members of the FOMC and hints of interest rate rises in 2023 and a slowdown of bond buybacks. However, this is bad news for the equities market, which has enjoyed the highest levels of liquidity for years.

In conclusion, without monetary tightening, high US inflation will start to grow exponentially as high energy prices start to cause similar rises across all sectors. The reality is that the record highs enjoyed in the market will not last as interest rates inevitably rise and liquidity levels fall due to a slowdown of bond buybacks. With a vast monetary tightening programme, everything points to inflation being transitory, how severely this will hit the market is still yet to be seen.

Comments

Post a Comment

Popular posts from this blog

Will The Fed Rise Rates By 2023?

Image
According to the Financial Times, the likelihood of rate hikes before the end of 2023 is now very high among economists. In a joint survey with the University of Chicago, 52 economists were polled on their views on whether they believed interest rates would be 50 basis points higher by the end of 2023, the results are shown below, in the form of a dot-plot, as used by the Fed. The results are  striking and closely resemble the sentiment of the Federal Open Markets Committee (FOMC) in the recent dot-plot published by the Fed after the June policy meeting, which is shown below. The views of the FOMC and that of academic economists being closely aligned means a scenario where interest rates are at least 50 basis points higher by the end of 2023 is now very likely to happen as a hawkish view is starting to take hold among both economists and the FOMC alike.  What will be the driving factor for rate hikes by the Fed?  In my opinion, the Fed is worried about the recent rising i...
Read more

What Did We Learn From Jerome Powell's Speech at Jackson Hole?

Image
Following Jerome Powell's speech at Jackson Hole, the S&P 500 rose 0.9%, as shown by the figure from the Financial Times below, and the Nasdaq rose 1.2% closing on an all-time high. The question then, is what did Jerome Powell say that made the markets react positively, continuing their climb to higher and higher highs. I am sorry to disappoint, but as boring as it may sound, there were no real fireworks to report from the Jackson Hole speech. However, Powell has given us an insight into the actions the Fed is likely to take over the coming months and years, giving the market some certainty about the future. We now know that the Fed has achieved the first of its two goals that it has set out to achieve before monetary tightening. The goal that has been achieved being average 2% inflation and the goal not yet achieved being the economy operating at full employment, though he indicated that there has been good progress in reaching full employment due to falling unemployment.   Al...
Read more