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Moderate Inflation in the Wings
We have been harping on the threat that inflation defined as "too much money chasing too few goods and services" will be a monetary phenomenon. The current case for higher inflation is easy to understand. The M2 measure of the money supply is up about 25% from a year ago, the fastest Y/Y growth in the post-World War II era. And while measures of overall economic activity such as real GDP and industrial production are still down from a year ago (pre-COVID), Americans' disposable incomes are substantially higher, boosted by massive payments from the federal government with more "stimulus" on the way.
The consumer price index is up only 1.7% from a year ago. But, this year-ago comparison is set to soar to 2.5%, or higher, as the economy drops off the big declines in prices during February - April 2020. The extent of this increase will likely be held back by the government's measure of housing inflation (which only focuses on rental values, not home prices).
Mark Twain once said, "History doesn't repeat, but it often rhymes." In the 1970s, if the Fed would have fought inflation harder early on, we would have never seen it hit double-digits. As a result, for now, the inflation threat seems more like the late 1980s, not the 1970s.
Consumer prices rose only 1.1% in 1986 as oil prices collapsed, but then it revived in 1987, rising above 4.0% by late Summer. To fight this rise in inflation, the Fed raised short-term interest rates by about 140 basis points, to about 7.3% from 5.9% towards the end of 1986. As the 10-year bond yield rose in 1987, the stock market took it on the chin and crashed in October. Alan Greenspan responded by providing as much liquidity as needed to restore confidence in the financial markets, and had the Fed cut short-term rates through early 1988. The money supply didn't soar, but short-term interest rates were lower than the trend in nominal GDP growth (real GDP growth plus inflation), signaling loose monetary policy.
Once the smoke cleared from the stock market crash, the Fed found itself behind in the inflation-fight. Inflation jumped to 5.4% in 1989, before Iraq invaded Kuwait, and then higher oil prices from the war pushed it to 6.3% after the invasion. As a result, the Fed eventually lifted short-term rates to almost 10.0% to get inflation under control. The result was the tight-money-induced recession of 1990-91, which some still wrongly blame on the Iraqi invasion.
We don't know if the late-1980s pattern is the one we're about to follow. What we do know is that just like with the stock market crash of 1987, the Fed has demoted inflation as its top concern and pushed COVID recovery to the top of its list. Letting M2 growth rise to 25%, and holding rates at basically zero, in spite of an economic recovery, is the proof.
The main question is how quickly the Fed turns its attention to inflation as it builds and how far will they go to fight it. In the 1970s, it was double-digit inflation, in the 1980s, it was 5% to 6% inflation. This Fed has made it clear that it will remain easy through 2022, bullish on the economy and stocks, but cautious on bonds as inflation picks up. 2023 now appears to be to see what history we rhyme with. As the US economy continues to rebound from its Covid-induced recession, the Fed projects GDP will grow 6.5% this year, a big jump from its previous estimate of 4.2% in December, although the central bank said it wouldn’t change its plans to a) leave interest rates near-zero through 2023 and b) buy $120 billion/month of bonds to stimulate the economy. (Source: FPAdvisors)
We have been harping on the threat that inflation defined as "too much money chasing too few goods and services" will be a monetary phenomenon. The current case for higher inflation is easy to understand. The M2 measure of the money supply is up about 25% from a year ago, the fastest Y/Y growth in the post-World War II era. And while measures of overall economic activity such as real GDP and industrial production are still down from a year ago (pre-COVID), Americans' disposable incomes are substantially higher, boosted by massive payments from the federal government with more "stimulus" on the way.
The consumer price index is up only 1.7% from a year ago. But, this year-ago comparison is set to soar to 2.5%, or higher, as the economy drops off the big declines in prices during February - April 2020. The extent of this increase will likely be held back by the government's measure of housing inflation (which only focuses on rental values, not home prices).
- Excluding rents, inflation will be more like 3.0% this year, and will likely move up by about another percentage point in 2022.
- Producer prices are up 2.8% from a year ago, with much faster growth in prices further up the production pipeline.
- Mortgage rates are beginning to spiral up for lows of 2.5% to 3.25%
Mark Twain once said, "History doesn't repeat, but it often rhymes." In the 1970s, if the Fed would have fought inflation harder early on, we would have never seen it hit double-digits. As a result, for now, the inflation threat seems more like the late 1980s, not the 1970s.
Consumer prices rose only 1.1% in 1986 as oil prices collapsed, but then it revived in 1987, rising above 4.0% by late Summer. To fight this rise in inflation, the Fed raised short-term interest rates by about 140 basis points, to about 7.3% from 5.9% towards the end of 1986. As the 10-year bond yield rose in 1987, the stock market took it on the chin and crashed in October. Alan Greenspan responded by providing as much liquidity as needed to restore confidence in the financial markets, and had the Fed cut short-term rates through early 1988. The money supply didn't soar, but short-term interest rates were lower than the trend in nominal GDP growth (real GDP growth plus inflation), signaling loose monetary policy.
Once the smoke cleared from the stock market crash, the Fed found itself behind in the inflation-fight. Inflation jumped to 5.4% in 1989, before Iraq invaded Kuwait, and then higher oil prices from the war pushed it to 6.3% after the invasion. As a result, the Fed eventually lifted short-term rates to almost 10.0% to get inflation under control. The result was the tight-money-induced recession of 1990-91, which some still wrongly blame on the Iraqi invasion.
We don't know if the late-1980s pattern is the one we're about to follow. What we do know is that just like with the stock market crash of 1987, the Fed has demoted inflation as its top concern and pushed COVID recovery to the top of its list. Letting M2 growth rise to 25%, and holding rates at basically zero, in spite of an economic recovery, is the proof.
The main question is how quickly the Fed turns its attention to inflation as it builds and how far will they go to fight it. In the 1970s, it was double-digit inflation, in the 1980s, it was 5% to 6% inflation. This Fed has made it clear that it will remain easy through 2022, bullish on the economy and stocks, but cautious on bonds as inflation picks up. 2023 now appears to be to see what history we rhyme with. As the US economy continues to rebound from its Covid-induced recession, the Fed projects GDP will grow 6.5% this year, a big jump from its previous estimate of 4.2% in December, although the central bank said it wouldn’t change its plans to a) leave interest rates near-zero through 2023 and b) buy $120 billion/month of bonds to stimulate the economy. (Source: FPAdvisors)
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