Discussing inflation -- Again
Inflation and its impact on Federal Reserve policy and interest rates have been recurrent themes in SriKonomics pieces. There was new backing over the past week for the view that inflation is likely to stay elevated for a long period of time. This is because temporary supply shortages, the favorite scapegoat of the central bank, may be only one of the many factors contributing to the sustainability of inflation.
The first source of support came from the Federal Open Markets Committee and Fed Chair Jerome Powell who ended a two-day meeting on Wednesday. Although Powell acknowledged that the Committee had started to think about tapering bond purchases, there appeared to be no urgency to the deliberations. The Chairman would not even acknowledge that an announcement regarding the timing of a new restrictive policy could come at the Fed get-together in Jackson Hole, Wyoming on August 26 - 28.
Powell justified the dovish decision by pointing to the uneven pace of recovery across different sectors and the new health risk from the delta variant. And of course, he still believes that inflation is “transitory” — again using that much used term — and mainly due to supply bottlenecks. Finally, the Fed has the tools to switch to a restrictive policy if it decides that inflation will continue at a high level for a prolonged period.
Powell’s judgment goes against the conclusion that the late Milton Friedman and Anna Jacobson Schwartz came to in their monumental study of US monetary history from 1867 to 1960. As Friedman put it, “there is much evidence that monetary changes have their effect only after a considerable lag and after a long period and that the lag is rather variable”. Which means that by the time the Fed decides to raise interest rates, the impact may not be felt anytime soon enough for it to be beneficial.
Investors’ consensus view following the Fed meeting is that central bank monthly purchases of $120 billion in bonds will continue at least through late-2021. That would mean that the Federal Funds rate will not be increased before 2022, at the earliest.
Adding to the inflationary pressures is the end yesterday to the national ban on eviction of tenants. With a Supreme Court decision preventing President Biden from extending the ban, evictions seem likely to increase sharply during August. No matter that of the $47 billion allocated for the Emergency Rental Assistance program, states have actually disbursed only $3 billion and, consequently, both renters and landlords are victims of the process. Rents, a significant contributor to the consumer price index, have been increasingly adding to overall inflation in recent months. They are likely to rise further as landlords evict tenants and increase rents to partially make up for losses due to delinquencies in past payments.
Lastly, the Employment Cost Index for the month of June showed that total compensation for civilian workers increased by 2.9% during the 12 months ending June 2021 compared with 2.5% in the 12 months ending December 2020 and 2.6% during the year ending March 2021.
The acceleration in wage costs substantiates the upward pressure on wages presaged by the JOLTS figures for May published by the US Bureau of Labor Statistics — that even though there were a record 9.2 million job openings, the overall unemployment rate remained elevated because of a skill mismatch. Employers are being forced to pay higher wages for workers who do have the skills, and this trend is not going to reverse anytime soon.
Signs are coming from different directions that the pickup in inflation has significant structural and cyclical components that monetary policy cannot rectify. Sticking with a failing policy will likely contribute to the permanence of inflation. That may come as a rude shock to bond investors who have decided that the best decision is not to fight the Fed.
Dr. Komal Sri-Kumar
President
Sri-Kumar Global Strategies, Inc.
Santa Monica, California
August 1, 2021
Sri-Kumar Global Strategies, Inc. advises multinational investors and sovereign wealth funds on global risk and opportunities. Dr. Sri-Kumar is regularly featured on business TV and Radio media, and is a frequent speaker in global financial centers on major topics that affect markets and investments.
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