The latest US inflation numbers: boosting recovery?

Today’s upside surprise in US consumer price inflation follows several other higher-than-expected increases, from China’s producer prices to Germany’s wholesale prices. Markets appear somewhat nervous as more and more statistical releases suggest rising inflation. Our view is that inflation is rising because of transitory factors, such as supply bottlenecks.

Central banks – including the Fed – have communicated, and quite clearly, that they are aware of such trends and consider these spikes as transitory. Our own analysis supports this view too, and suggests that what’s boosting inflation is the combination of base effects, the feed-through of commodity price increases and various input shortages.

Conversely, we don’t see the strength in wage growth or the tightness in labour markets and in factory utilisation rates that are normally associated with protracted inflation spikes. This is why we expect inflation to peak over the next few months and to slow again in the second half of the year, eventually getting back to central banks’ targets.

Even though the inflation pickup was expected, most forecasts didn’t foresee such a big jump. It’s fair to say that some of the key inflation indicators have tended to rise more than the consensus had envisaged recently. This is what appears to have impacted stock markets over the past 48 hours, with tech shares once again retreating on fears that higher inflation may prompt central banks to hike rates sooner than expected.

Calibrating the magnitude of the inflation overshoot after a shock as big as the pandemic is going to be quite tough for market participants. This may raise volatility for a period of time. However, the major economies continue to recover, supported by reopening and stimulus.

More economic data; more upside surprise. The US CPI numbers were well ahead of expectations, the month on month figure showing an acceleration on the rate on the growth in March, making it the biggest jump since 2009. This has to be getting concerning for the Fed now. This will lead yields and the dollar higher and dampen the outlook for growth stocks.

Derek Zoolander is not an ambiturner. He can’t turn left. Nor, it seems, can Jerome Powell. But there’s nothing funny about the potential long-term consequences to how Fed policy is being run. Catalysed by receding Covid uncertainty, the economic recovery is booming. Consumption is up, construction is thriving and labour markets are tightening. Ordinarily, the Fed might be planning its first-rate hike around now but apparently this won’t happen for some time. That’s because Powell is running the Fed like he’s a football manager going into extra time… but he hasn’t heard the final whistle.

That’s what happens when your policy is tone-deaf. To be clear, I’m not accusing Powell of being tone-deaf to the needs of the people, far from it. By focusing on maximum employment over price stability, he is getting America back to work. That’s important. Further, within the employment objective Powell is increasingly focused on social policy. Whilst that is entirely admirable, and the Covid crisis offers the opportunity to do just that, it is arguable that such an endeavour goes beyond his monetary remit, particularly at a time when rampant fiscal policy seeks to do just that.

In fact, the Fed’s whole approach to employment seems off. There are now 9.8 million unemployed people in the US but there are also 8.1 million job openings, the highest on record. Powell seems to think that the solution to this supply-demand imbalance is more quantitative easing and lower for longer interest rates. But these tools have contributed to growing inequality, not less, and will not cause people to take those jobs if they don’t want them.

Indeed, there is growing evidence that employers are struggling to lure prospective employees back to the jobs market due to wage competition from government transfer payments, as evidenced by last week’s average hourly earnings data which jumped 0.7% month-on-month. Alternative explanations for the supply-demand imbalance include skills mismatch and the additional burden placed on parents while schools remain close. These issues cannot be resolved by more-of-the-same monetary policy.

Instead, Powell may have become tone-deaf, or blind-sighted, towards financial stability risk. There’s a reason house prices are up, SPACs are a thing and crypto investors have netted quintuple percentage gains this year alone… and it all speaks to rampant asset price inflation. This inflation is now spilling over to the real economy and that’s what we’ve seen today with year-on-year CPI at 4.2%, way ahead of consensus for 3.6%. Stripping out the base effects, month-on-month inflation also rose, up 0.8% versus consensus at 0.2%.