Inflation Is All Around Us

We are seeing an explosion in prices around the world, and the Fed is rather pleased about it.  Well, they are not totally pleased but satisfied to a point. It's been said for a decade that the Fed had been wanting to see some inflation creep into the economy but it has been nascent for years. But isn't it odd that the chief inflation fighter (the Fed), with a track record of 42 years and growing would want to see inflation rising? It certainly makes one scratch their heads.

Let's peel back the onion a bit so we can figure this out together.  After the Great Financial Crisis (GFC) in 2008/09 there was a strong urge for companies to lower prices as demand for end products was very weak.  This was due to substantial job losses and sharp financial moves down in the stock market. Without getting into too much detail, prices started spiraling lower at a swift pace, hence the Fed saw its roll to reverse this trend by purchasing bonds (QE) and keeping rates as low as possible.

In previous times and other economies this trick worked nicely and it seemed this time around it would work, the Fed had an open-ended timeline.  But even Fed Chair Bernanke wasn't able to ignite inflation much with three different QE programs.  The 2% goal they set in 2011 was elusive.  

In 2020 the pandemic forced the Fed to make some quick maneuvers in order to keep the economy from a spectacular attack.  Chair Powell used all of the tools at his disposal to head off the undesired deflation that occurred just ten years earlier. It seems to have worked this time. Supply chain issues, strong end demand, re-pricing of goods and sticky price increases are all happening today.  

This is why it should not be a shock to see large increases in the consumer price index (CPI) and other measures of inflation.  The question today is how much longer will the Fed accept strong inflationary trends?  Inflation expectations are still rather contained, FRED data says 10 year inflation breakeven rate today is just 2.27%.  

But 2.2% is not the rate of inflation today, in fact it's much higher.  How much longer can the consumer's buying power be sapped by rising prices?  Further, wage increases are not even close to keeping up with price inflation, so fewer dollars coming after goods. There is a huge disconnect that credit seems to be filling in the gaps. If demand ever falls off a cliff prices will again come tumbling to earth.

We are all feeling the effect of higher prices in all aspects of our lives:  groceries, travel, vacation, gasoline, shopping.  It doesn't feel good when the cost of a used vehicle is up 30% from a few short months ago for no apparent reason.

It's a difficult challenge for the Fed to determine the right timing of tighter policy.  The pandemic is not getting better and we are not seeing the robust job gains on a consistent basis the Fed is looking for.  That may change soon, hence policy is probably closer to a moderate change than none at all.