In contrast to the proverbial monkey, there are those that “see, hear & speak” inflation

From Goldman Sachs:

“During most of the post-crisis recovery, inflation risks have been subdued.

However, concerns with “overheating” and higher inflation are now being raised given a combination of strong global growth and diminishing economic slack, increasing labor market tightness, expansionary fiscal policy vs. only gradual normalization of monetary policy in the U.S., risks from trade protectionism / retaliation, and the potential for higher commodity spot prices as inventories continue to draw down,” writes Goldman Sachs strategist Michael Hinds.

“There’s really no question – inflation is rising.” –  @inflation_guy

His yardstick: The New York Fed “Underlying Inflation Gauge” (UIG)

“Underlying Inflation Gauge…first time over 3% since 2006.”

The New York Fed, however, has warned:

Recent analysis suggests the rise in the full-data-set UIG compared to the prices-only measure is being driven principally by survey measures of manufacturing and nonmanufacturing activity.

When you look at a “basket” of inflation indicators, only by introducing “survey measures of economic activity” you get an upward tilt in inflation.

Inflation is going to head up this year — on that there isn’t much debate.” Greg Ip:

If inflation turns up, economists have long assumed it would do so slowly, giving the Fed plenty of time to respond. But Michael Feroli of J.P. Morgan notes this assumption is built on models in which the world behaves in a predictable, linear way. In fact, he says, the world isn’t linear and inflation can change suddenly for unexpected reasons: it “is sluggish and slow-moving, until it isn’t.”

A case in point: in 1966, inflation, which had run below 2% for nearly a decade, suddenly accelerated to over 3%. Some of the circumstances echo the present: unemployment had slid to 4%, taxes had been cut and federal spending for the Vietnam War and Lyndon Johnson’s “Great Society” programs was surging.

“Consumer prices rising at a 2.1 percent rate could be toxic when combined with very low unemployment.” Tim Duy:

This persistent period of low unemployment feeds into the Fed’s forecast and comes out as faster inflation. The projections now show that central bankers expect inflation to surpass the target, rising to a high of 2.1 percent at the end of 2019.

In other words, the Fed is explicitly forecasting overshooting the inflation target. Policy makers could crank up the interest rate forecast to eliminate that overshooting but instead have chosen a less aggressive policy path. [If you call 0.1 overshoot, what do you call -1 or -0.5?]

Duy´s conclusion:

The Fed increasingly relies on a very flat Phillips curve even as unemployment rates head toward levels not seen in five decades. If there is a nonlinearity in the Phillips curve and inflation starts to pick up more aggressively, this bet is going to go sour quickly.

What both GI and Duy have in mind is a chart like the one below. With unemployment now quickly approaching 4% and, according to FOMC projections, expected to fall further, GI & Duy imagine a repeat of the 1960s, when the PC was flat until it wasn´t!

It´s discouraging when you see that the conventional wisdom still squarely believes inflation is an “unemployment phenomenon”, and that the Fed controls inflation by “nudging” the unemployment rate. Again from TD:

If Fed officials were determined to avoid an overshoot, they would need to act more aggressively to push unemployment up toward their estimate of the natural rate.

From GI:

The Federal Reserve is attempting in the next few years something it has never accomplished before: guide unemployment up without causing a recession. It faces high odds of failure–and little alternative path.

Many economists have to realize that the rising inflation in second half of the 1960s did not come about because of “too low” unemployment, but because monetary policy (indicated by NGDP growth) was in an expansionary roll. That´s certainly not true at present.

All that leads to one of the more “tongue-twisting” comments I´ve ever heard from a FOMC member:

Neel Kashkari:

Mr. Kashkari, in his comments Friday, said his support of the latest rate increase comes down more to defending the central bank’s credibility under a new chairman, rather than a shift in his fundamental outlook.

“If I had been sitting in the chairman’s seat, I would have raised rates because we told the markets we were going to raise rates,” Mr. Kashkari said. Boosting short-term rates “represented continuity with what the Federal Reserve said it was going to do.”

However, “we have a ways to go” before achieving the Fed’s job and inflation goals, and “there’s still some slack in the labor market,” Mr. Kashkari said. And on that front, “I don’t think the data itself supports rate increases at this point.”

image_pdf
Share

Leave a Reply

Your email address will not be published. Required fields are marked *