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Macroeconomic & Geopolitical

A Few Sparks & Lots of Smoke—But Still No Sign of a Fire

30 April 2021 - 3 min read

As investors search for signs of uncontrolled inflation, it’s hard to see anything more than you’d expect in a strong cyclical recovery.

My corner cup of coffee now stands at $2.41, a tank of gas costs 37% more than a year ago, and local home prices are setting new records. Given the powerful confluence of vaccines, government stimulus, and cheap central bank funding, is the Federal Reserve about to lose control of prices? Could inflation float straight through the Fed’s 2% target and trigger a tightening as they head for 4%?

Abundant loose talk may conjure up frightening scenarios, but taking each argument separately suggests the normal sparks of a strong cyclical recovery are still unlikely to ignite a sustained fire.
 

1. “It’s in the data!” Actually, it’s not in the data, because so much of the current statistical stream records year-on-year bounces from last year’s lockdowns. Consumer Price Inflation rose 2.6% over last March, but strip out food and energy prices and the reading falls to 1.6%. The Fed’s preferred measure of Core Personal Consumption Expenditure can’t even touch 2% with an easy comparison to price levels when the world literally shut down.
 

U.S. CORE PCE (PERCENT)

Source: Bloomberg. As of April 29, 2021.


2. “But you can’t exclude food and gas!” Brent crude has more than doubled off its lows but still remains near pre-pandemic levels. Prices could rise further as the economy reopens, but OPEC’s spare capacity and dormant U.S. shale producers mean there will be limits. Steel prices have soared as supply constrained by lockdowns struggles to catch up with demand. Environmental concerns may keep prices higher than historical levels, but likely lower than the current surge. Global corn and soybean prices have risen as China rebuilds hog herds decimated by African swine fever, but that hardly counts as a structural market shortage.
 

3. “Financial markets are worried.” Sort of. Treasury yields have been rising with the recovery, but, as IMF economists point out, concerns about breakeven inflation are concentrated in the next few years of the current cycle rather than anything more lasting.
 

U.S. TREASURY REAL YIELDS (PERCENT)

Souce: U.S. Department of the Treasury. As of April 29, 2021.


4. “Those stimulus checks are sure to touch off a spending spree!” A boomlet will come as shoppers catch up from a long winter lockdown, but at least one survey shows that Americans have been spending barely a third of their government support checks, allocating the rest to pay down debts or boost savings. These are hardly the makings of a sustainable binge.
 

5. “Have you seen gold? And what about bitcoin, SPACs and non-fungible tokens?” Yes, gold is up sharply in April but still not much higher than a year ago when the Fed and Congress launched the largest money creation exercise in U.S. history. Elsewhere, there sure appears to be a lot of good money chasing dubious investments. NFTs, which offer original rights to easily reproducible digital art, carry an echo of Dutch tulips, Pet Rocks and those limited-edition dolls your daughter insisted on collecting. Still, these are pockets of market excess rather than anything that will trigger tighter financing conditions.
 

6. “U.S. house prices are soaring!” Indeed they are. And they were soaring before the pandemic and the government response, too, for the simple fact that supply has been limited. This could be a big problem, except that a third of Americans rent their lodgings and rents are still well below pre-crisis levels for the most part.
 

GOLD (USD)

Source: Bloomberg. As of April 29, 2021.


7. “Costs are rising if you listen to the corporate earnings calls.” This would be worrying if rising costs are in fact due to fracturing globalization and trade wars, but many of the complaints stem from temporary bottlenecks as demand snaps back. Clogged ports and rising shipping costs may crimp corporate profits, but so far there is plenty of room to absorb the shocks.  Structural issues around semiconductors pose risks to some industries, but it’s hard to imagine the technology sector—where prices have fallen steadily for decades—suddenly driving consumer price baskets higher.
 

8. “Falling unemployment? Higher wages? Phillips curve?” Uh, no.
 

9. “But this time wages do seem to be rising!” They have been rising for skilled labor, and this is clearly something to watch. For unskilled labor, however, there’s little sign of recovery, and indeed every sign that many have left the workforce altogether as technology continues to displace them.
 

10. “What about rising inflation expectations?” Over the last year, expectations have risen, reflecting all these temporary factors. Still, they remain below 2018 levels, which doesn’t signal any long-term concern.
 

If you’re still looking for inflationary flames, though, keep your eyes on expectations. Price increases could theoretically become part of the global economic bloodstream again, as they were in the 1970s, if we are wrong about other items on the list. But we’d have to be very wrong about almost all of them, which is what keeps us relaxed for now about the sparks, the smoke, and the price of coffee.

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