How to Make Sense of the Surprising Inflation Signals
(Bloomberg Businessweek) -- We’ve been told for years that inflation has been too low. Now that it’s finally reached and surpassed the Federal Reserve’s 2% target, it looks as scary as the fast-growing carnivorous plant in Little Shop of Horrors.
Iron, copper, lumber, cotton, computer chips, and gasoline are jumping in price. The dollar has weakened, making imports more costly. Employers are having to raise wages to fill record openings; the federal government is spending heavily; and consumers emerging from the pandemic are in the mood to light some money on fire. On May 12 the U.S. Bureau of Labor Statistics reported that consumer prices rose 0.8% in April from March, four times the median expectation and the most since 2009. Excluding food and energy the increase was 0.9%, the most since 1982.
Stock indexes have retreated since May 7, when the S&P 500 hit a record. But jitters about the economic equivalent of an out-of-control, man-eating houseplant are more clearly evident in the bond market. Investor bets on the average inflation rate over the next 10 years have shot up from their Covid‑19 low of less than 1% in 2020 to more than 2.5%, the highest since 2013.
The nervousness may get worse. “One always has to be careful not to overplay a few anecdotes and project that onto the broader economy,” Douglas Porter, chief economist at BMO Capital Markets, wrote in an April 30 report. “But as the anecdotes accumulate, they eventually become data.”
So how worried should we be? This package of stories tries to answer that question. It focuses mostly on the U.S. but also takes a look at China, where manufacturers are beginning to pass along their higher costs to customers around the world.
Price pressures can bubble up at different stages in a supply chain. A lot of the pressure now is in commodities. At $66 a barrel, West Texas Intermediate crude is trading at its highest level since 2014 and far above its price of $20 or so during the worst of the Covid downturn. Bottlenecks including the ransomware-related shutdown of a major East Coast fuel products pipeline add to volatility. What’s worse is that other raw materials are surging in tandem. A Bloomberg index of 20 commodities has climbed 53% over the past 12 months.
Commodity costs are only a small component of most consumer prices, of course. The consumer price index doesn’t move up or down as dramatically as the indexes for producers at various stages of production. Nonetheless, it’s worth noting that oil, the most important industrial commodity, has been a catalyst for every big spike in consumer price inflation since the early 1970s.
Wages are the biggest expense for most companies, and they, too, are moving up. Some observers interpreted the big shortfall in April jobs growth—a payroll increase of just 266,000, vs. the expected 1 million—as a sign that demand for workers is flagging, and so they conclude that runaway inflation isn’t an imminent threat. Another way to read the May 7 report from the Bureau of Labor Statistics is that job growth is being held back by a shortage of workers, in which case businesses will have few options but to hike pay to fill openings. Under this scenario, inflation becomes a clear and present danger, as Bloomberg Opinion columnist Mohamed El-Erian wrote on May 10.
Although payrolls are still down 8 million jobs, data released on May 11 showed the national job-vacancy rate has shot up to 5.3%, the highest since records began in 2000. Fear of Covid, child-care issues, skills mismatches, and generous jobless benefits are all suspected factors in why workers are staying home. To lure them, companies are offering signing bonuses and raising wages. The employment cost index, which covers both wages and benefits, rose in the first quarter at the fastest pace since 2007.
Some companies are passing along their higher labor and materials costs to customers, according to transcripts of earnings calls with analysts. “Straight price increases will continue to be an important element as we look at the back half of the year,” Noel Wallace, chief executive officer of Colgate-Palmolive Co., said on April 30. Paul Jacobson, General Motors Co.’s chief financial officer, told analysts on May 5 that the automaker’s average transaction price was up 9% year-over-year in the first quarter, “helping to overcome headwinds from commodity inflation and lower volumes.” Tyson Foods Inc. Chief Operating Officer Donnie King said on May 10, “We certainly can’t eat all the inflation that we’re experiencing now.”
Fiscal and monetary stimulus are also pushing up prices. Federal net outlays hit 31% of gross domestic product in the final quarter of 2020, way above the recent average of about 20%. The Biden administration has kept the pedal to the metal since then with the $1.9 trillion American Rescue Plan and is seeking Congress’s approval for other spending. And the Federal Reserve has maintained the target range for the federal funds rate at 0% to 0.25% while continuing to buy $120 billion a month of Treasury and mortgage-backed securities to hold down long-term rates.
Fed officials say higher inflation is precisely what they want. A bit of predictable inflation lubricates commerce and gives the central bank room to push down inflation-adjusted rates to revive the economy next time there’s a crisis. On April 28 the Federal Open Market Committee (FOMC) unanimously reaffirmed its commitment to achieving inflation “moderately above 2% for some time” to compensate for the many years it was under 2%.
Fed Chair Jerome Powell has repeatedly stressed that the current inflationary pressures are “transitory” and that it’s too early to even talk about tightening monetary policy while unemployment remains this high. “We have pent-up demand in the economy,” said Fed Vice Chair Richard Clarida on May 12, calling the April inflation figure just “one data point.” He added, “It may take some time for supply to rise up to demand.”
He and others point out that the elevated year-over-year inflation readings are distorted by extremely weak prices from the Covid-damaged economy a year ago—and say that too-high inflation is easier for the Fed to fix than too-low inflation.
The one thing that could get the Fed to raise rates soon would be evidence that consumers and businesses are beginning to expect high inflation, which can become a self-fulfilling prophecy. There’s no sign of that happening yet, Clarida said in an April 14 speech. He pointed to a Fed staff compilation of 21 indicators from households, companies, professional forecasters, and markets showing that expected inflation was 2% in the first quarter, on target.
Some Wall Streeters say the Fed is right to stay the course. “We do not see the sort of inflationary pressures that markets appear to be fearing, and high growth rates will not necessarily translate into a higher inflation rate,” says Praveen Korapaty, Goldman Sachs Group Inc.’s chief interest-rate strategist.
That may well turn out to be right. At the moment, though, the mood is fearful. And the more the Fed tries to reassure people that inflation is nothing to worry about, the more some people will conclude that it’s about to get out of hand. —With Michelle Jamrisko and Vivien Lou Chen
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