Inflation Inflation, what will you do?
Inflation is building up - or is it?
In my previous blog I almost admitted I had been a bit premature, forecasting looming deflation. However, thinking about it (and stirring the tea leaves at the bottom of the economic cup), the conclusion dawns that, although there are lots of question marks about the build up of inflationary pressure (mainly from the energy sector), in actual fact the equation is a lot more complex than one of "high oil prices mean higher inflation". Still, as this chart (courtesy of Contrary Investor) shows, the US experience is either pointing towards an upsurge in core inflation, pulled up by the headline number - or it's not:
Add in the strong move up in pipeline inflation (PPI) - crude and intermediate goods, and it is little wonder gold is reaching new highs. However, financial markets appear to be much more sanguine about the outlook for inflation - true, the bond market is getting nervous about inflation, but yields still look remarkably low.
The question is, therefore, whether inflation is building up a head of steam, requiring a stern policy response, or is in fact a one-off spike, which will tail off all on it's own, without the need for restrictive policies from the world's central banks.
And there's the rub, because it seems that the US Fed's easy money policy may have masked economic weakness for the last 5 years (helped by a few tax cuts, of course, but that weakness is getting ready to break cover, just as the Fed raises rates to stifle inflation. So inflation pressure may be building up, and there is probably no doubt that the labour force will try to recover spending power lost to inflation by demanding higher wages, but how successful will they be? At present US firms are reporting very strong profit margins, having spent the last few years trimming costs, and the Fed has indicated that it is watching earnings data to see if they will be used to absorb pressure from rising raw materials prices; unfortunately, recent Fed surveys have shown an increasing ability of some firms to pass on cost increases, which is bad news for interest rate doves. It seems highly unlikely CEOs will succumb to a bout of conscience, and start pushing up wages simply because of the squeeze on their workers' pockets. So, as usual some workers - those who still have some clout - may squeeze more from their employers, in general earnings are probably flat-to-down. Witness the good old UAW, which 4 months ago was laughing in Rick Wagoner's face as he pleaded for help to prevent GM sliding into bankruptcy, but which has now made a significant concession regarding healthcare benefits for hourly workers.
What does that have to do with cost-push inflation, as mentioned above? For some time many respected pundits have been questioning the ability of the US consumer to keep on spending - the maximum has been extracted from the house, credit cards are maxed-out, and the new bankruptcy law has just been introduced (although that will probably only affect the margins), and the question is whether companies can push through price increases as consumers slow their spending.
Obviously the basics, such as food, heating and housing, are much more price-inelastic, and thus the core figure has not tracked the headline data (yet). Plus the Fed has (in my opinion) been watching the fall in consumer good prices, and (with a calculator, pencil and a rubber...) offsetting the rise in one with the fall in the other, but as we cannot quantify this "tinkering", I am going to ignore it. But, with earnings growth soft and rising prices for essentials, what chance companies can make price rises stick? It seems unlikely, unless workers are able to force through wage rises, which seems unlikely unless US companies can get some form of protection from external competition. In short, the scenario leading to a sustained bout of inflation looks very unlikely.
Having said that, a lot of writers AND generic inflation indicators are saying inflation is looming; and if we see more big numbers in prices paid/prices received surveys, and big PPI and CPI figures, the Fed is almost bound to continue tightening past the current mooted target of 4.25/4.5%. If the inflation scare is a false alarm, what would rates above here do to the American consumer? And if the American consumer gives up, what happens to the rest of the world? I reckon we are back to the deflation scenario. Sometimes it pays to ignore the incidental detail and keep your eye on The Big Picture.
Joss Bolton
In my previous blog I almost admitted I had been a bit premature, forecasting looming deflation. However, thinking about it (and stirring the tea leaves at the bottom of the economic cup), the conclusion dawns that, although there are lots of question marks about the build up of inflationary pressure (mainly from the energy sector), in actual fact the equation is a lot more complex than one of "high oil prices mean higher inflation". Still, as this chart (courtesy of Contrary Investor) shows, the US experience is either pointing towards an upsurge in core inflation, pulled up by the headline number - or it's not:
Add in the strong move up in pipeline inflation (PPI) - crude and intermediate goods, and it is little wonder gold is reaching new highs. However, financial markets appear to be much more sanguine about the outlook for inflation - true, the bond market is getting nervous about inflation, but yields still look remarkably low.
The question is, therefore, whether inflation is building up a head of steam, requiring a stern policy response, or is in fact a one-off spike, which will tail off all on it's own, without the need for restrictive policies from the world's central banks.
And there's the rub, because it seems that the US Fed's easy money policy may have masked economic weakness for the last 5 years (helped by a few tax cuts, of course, but that weakness is getting ready to break cover, just as the Fed raises rates to stifle inflation. So inflation pressure may be building up, and there is probably no doubt that the labour force will try to recover spending power lost to inflation by demanding higher wages, but how successful will they be? At present US firms are reporting very strong profit margins, having spent the last few years trimming costs, and the Fed has indicated that it is watching earnings data to see if they will be used to absorb pressure from rising raw materials prices; unfortunately, recent Fed surveys have shown an increasing ability of some firms to pass on cost increases, which is bad news for interest rate doves. It seems highly unlikely CEOs will succumb to a bout of conscience, and start pushing up wages simply because of the squeeze on their workers' pockets. So, as usual some workers - those who still have some clout - may squeeze more from their employers, in general earnings are probably flat-to-down. Witness the good old UAW, which 4 months ago was laughing in Rick Wagoner's face as he pleaded for help to prevent GM sliding into bankruptcy, but which has now made a significant concession regarding healthcare benefits for hourly workers.
What does that have to do with cost-push inflation, as mentioned above? For some time many respected pundits have been questioning the ability of the US consumer to keep on spending - the maximum has been extracted from the house, credit cards are maxed-out, and the new bankruptcy law has just been introduced (although that will probably only affect the margins), and the question is whether companies can push through price increases as consumers slow their spending.
Obviously the basics, such as food, heating and housing, are much more price-inelastic, and thus the core figure has not tracked the headline data (yet). Plus the Fed has (in my opinion) been watching the fall in consumer good prices, and (with a calculator, pencil and a rubber...) offsetting the rise in one with the fall in the other, but as we cannot quantify this "tinkering", I am going to ignore it. But, with earnings growth soft and rising prices for essentials, what chance companies can make price rises stick? It seems unlikely, unless workers are able to force through wage rises, which seems unlikely unless US companies can get some form of protection from external competition. In short, the scenario leading to a sustained bout of inflation looks very unlikely.
Having said that, a lot of writers AND generic inflation indicators are saying inflation is looming; and if we see more big numbers in prices paid/prices received surveys, and big PPI and CPI figures, the Fed is almost bound to continue tightening past the current mooted target of 4.25/4.5%. If the inflation scare is a false alarm, what would rates above here do to the American consumer? And if the American consumer gives up, what happens to the rest of the world? I reckon we are back to the deflation scenario. Sometimes it pays to ignore the incidental detail and keep your eye on The Big Picture.
Joss Bolton
posted by Jambutty at 7:15 am
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