The Economy Just Got Hotter, but That Might Be a Bad Thing

A big jump in consumer prices has some experts worrying that inflation is inevitable, despite calming statements from the Federal Reserve and White House.

In this photo provided by the New York Stock Exchange, trader Frank O’Connell works on the floor, Tuesday April 13. Stocks were choppy and mixed in late morning trading Tuesday as a drop in bond yields hurt bank stocks but helped big technology stocks. (Nicole Pereira/New York Stock Exchange via AP)

MANHATTAN (CN) — Consumer prices saw the biggest jump since August 2012 on Tuesday, leading some experts to worry that federal regulators are not taking inflation seriously enough.

Tallied in a new report from the Bureau of Labor Statistics, the consumer price index rose 0.6% in March after a 0.4% increase the previous month. The numbers confirm what many economists have been predicting, and worrying about, in recent weeks.

“The outsized 0.6% rise in consumer prices in March, driven in part by a 0.3% rise in core CPI, is the clearest indication so far that the signs of mounting inflation evident in business surveys and producer prices are feeding through to stronger consumer prices,” Michael Pearce, senior U.S. economist at Capital Economics, wrote in an investor’s note.

Concerns about an overheating economy have been floating around since the beginning of the year, but persistent data is drowning out sanguine statements from the Federal Reserve and White House.

Most of the March jump was due to the 9.1% month-over-month increase in gasoline prices last month. Though experts called it a one-off as energy prices have begun to stabilize, the rise in core inflation and inflation excluding food and energy were both one-tenth more than most experts had predicted and the quickest since 2009. Even airline prices gained, seeing a 0.4% increase in March as more fliers are vaccinated and lockdowns pare back.

“These can’t be explained away by easy comps,” said Peter Boockvar, chief investment officer at Bleakley Advisory Services, noting that year-over-year the increase in inflation was 2.6%.

The price increases were almost across the board, with only apparel seeing a drop. And while food prices gained just 0.1% the last month, many experts predict those prices to ramp up later in the year to hit 0.3% monthly price gains.

“Clearly, the stimulus programs and surging government debt are going to put upward pressure on prices through 2021, but it is unclear if the ‘inflation genie is out of the bottle’ as we enter 2022,” said Michael Pagano, a finance professor at Villanova University. “So even though there will be strong pent-up demand first in the U.S. and then elsewhere, the demand should be met by increased global supply.”

Regulators say they are closely monitoring the inflation rate, but by their own accounts they seem to welcome higher inflation. During a speech before the Chicago Council on Global Affairs last week, Treasury Secretary Janet Yellen said that “the problem for a very long time has been inflation that’s too low, not inflation that’s too high.”

Yellen also said she doesn’t think the recently enacted $1.9 trillion fiscal package would exacerbate inflation. “We’re in a deep hole, the U.S. economy is still down around 9 million jobs,” noted the secretary, who is a former Federal Reserve chair. “If the package did prove to be inflationary, we do have the tools to address it.”

The Fed also has remained sanguine about inflation. Jerome Powell, the central bank’s current chair, last summer announced the Fed would keep its interest rates near 0% until inflation reaches a long-term average of 2%. In countless speeches since, Powell has failed to fully define how long average inflation must tick that 2% box before the central bank changes its monetary policy approach. During a “60 Minutes” interview on Sunday, Powell reiterated that the central bank plans to “wait to see real inflation” before changing its approach.

On Monday, two of the Biden administration’s leading economists, Jared Bernstein and Ernie Tedeschi, noted that “in the next several months we expect measured inflation to increase somewhat” based on supply-chain disruptions and pent-up demand due to Covid-19. They also predict, however, that these factors “will likely be transitory, and that their impact should fade over time as the economy recovers from the pandemic.”

Federal Reserve Bank of Boston President Eric Rosengren, left, speaks during a roundtable discussion at Silver Lane Elementary School in East Hartford, Conn., on Nov. 25, 2019. Federal Reserve Board Chair Jerome Powell is pictured in the background. (AP Photo/Steven Senne)

By their estimates, either March or April will likely represent a “base effect” of the turnaround, when prices would jump due to the waning virus. They pointed to the converse base month of April 2020, when prices plummeted.

Some are skeptical about that prediction. “Base effects alone will drive headline inflation close to 4% by May, and core inflation above 2.5%,” Pearce wrote. “The Fed will look through that temporary effect, but with the economy likely to be operating above capacity by next year and wage pressures likely to mount we expect core inflation will average close to 2.5% in 2022 and 2023 too.”

Pearce added that, “for all the focus on supply disruptions pushing goods prices higher, the strongest upward pressure on prices is coming from the services sector.”

There is also analysis suggesting that inflation, for all the concern brewing, may be only a short-term issue. DataTrek Research put expected inflation among 5-year Treasury Inflation-Protected Securities at the highest point in decades, around 2.52%, while 10-year expected inflation is slightly less at 2.33%.

So-called TIPS pay twice a year and adjust for inflation for deflation, so they pay at either the adjusted principal or the original principal, whichever is higher, when they mature. As such, they can be a good backstop against inflation for some investors.

“Typically, expected longer-run inflation is higher than over the shorter term,” wrote Nicholas Colas, co-founder of DataTrek. “Put another way, the TIPS market is saying that the second half of the decade should see quite a bit less inflation than the next 60 months.”

Colas added: “Markets are quite sure inflation will pick up temporarily but are much less convinced this is sustainable.”

Pagano also says the Fed’s current posture is likely the correct one, but it depends heavily on what the Biden administration does regarding taxation and spending.

“The increased inflation risk is further down the road,” Pagano said, pointing to 2024 and beyond, “if we continue to do more deficit-inducing spending on more stimulus or other social programs, as this government borrowing can eventually ‘crowd out’ corporate borrowers and lead to higher interest rates.”

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