Economists are stunned by the 6.2% yearly surge in consumer spending. This has investors’ worry, and the government’s concerned as inflation remains hot. This has signaled the fifth straight month that the consumer-price index exceeded 5%, and signaled the largest jump in consumer price inflation since July 1982.
While some of the pricing pressures stem from reopening bottlenecks, there is more to the story. Transitory inflation components account for one to 1.5 percentage points of core CPI, which excludes food and energy, says Aneta Markowska, chief economist at Jefferies. That means so-called sticky inflation is running well above the Federal Reserve’s
longstanding 2% target.
An under-the-radar metric—the underlying inflation gauge—created by the New York Fed provides “a measure of underlying inflation and is defined as the persistent part of the common component of monthly inflation,” according to that bank. Published monthly but compiled daily to closely monitor changes in sticky inflation, the UIG has been soaring since February and stands at a record high of 4.3%.
Because the Fed’s justification for overshooting on inflation rests on the idea that inflation undershot for a decade, it’s worth looking at the UIG’s history. Contrary to conventional wisdom, the Fed’s own gauge shows inflation ran below 2% only for three relatively short stretches over the past decade: March 2012 through April 2014; December 2014 through November 2016; and February 2020 through February 2021.
“It’s an inconvenient truth,” says Eddy Vataru, chief investment officer for Osterweis Capital Management’s Total Return Fund. “When you look back at the UIG, there’s not really a long period of under-2% inflation.”
This begs the question: If prices were higher than advertised in the past decade, is inflation even worse now than it looks?
The latest surge in inflation has occurred at a time when debt has ballooned across the economy, making the prospect of higher interest rates particularly problematic. If the Fed is even further behind the curve than some observers fear, how will it cool inflation in an economy that couldn’t tolerate 2.5% interest rates during normal times?
Officials waited too long to taper and may thus have to chase down inflation aggressively, says Diane Swonk, chief economist at Grant Thornton. It’s possible the Fed raises rates three times
in 2022 and another five times in 2023; the yield curve inverts, demand slows, and inventories go from tight to bloat, pushing the economy into recession, or worse, in 2024, she says.
Or, more likely, the Fed will continue to wait. Due to personnel changes, the policy-setting committee turns more dovish next year, with or without Chairman Powell, meaning officials are more apt to wait, possibly in vain, for labor-force participation to return to pre-pandemic levels. Waiting to raise rates increases the likelihood that money velocity rebounds to its pre-Covid trend, implying a more-than-20% rise in nominal demand from current levels, pushing prices higher, says Michael Darda, chief economist at MKM Partners.
The latter scenario requires a prolonged suspension of reality. But as the Fed winds down its bond-buying program and the Treasury market begins to speak for itself again, reality may arrive.