U.S. shoppers know too well inflation is here. The Federal Reserve insists the situation is temporary, as prices will go lower as the pandemic becomes less of an issue.
But what if the Fed is wrong, or only half right? The economy would be weaker than it appears.
"The trend is not the Fed’s friend," Apollo Global Management chief economist Torsten Sløk told Barron's.
Grocery shoppers, home buyers, manufacturers, and retailers all say their dollars are buying less. Their day-to-day survival can’t ignore the food and energy costs that are backed out of price metrics preferred by policy makers.
Average Americans also notice the 17% jump in existing-home prices that isn’t directly figured into such gauges.
"They say it’s temporary and there are supply-chain issues, but there is huge demand," Mike Procopio, CEO of Massachusetts-based Procopio Cos., said of prices overall, from lumber and steel to labor. "It’s a vicious cycle. If it costs me 20% extra to build, rents will have to go up 20%."
Investors already are worried the Fed might be behind the curve. Consumer price index data from this past week show prices rose 4.2% in April, or 3% without food and energy.
A record number of businesses say they can’t find workers, inventories are low, and a near-record number of companies say they plan to raise prices, as they predict costs rapidly rising.
For the average American household, food, energy, and shelter combined represent roughly 50% of income before taxes.
Still, monetary and fiscal policy remains unchanged, geared to an economy stuck in recession. Also, the Fed’s favorite inflation gauge remains close to its longstanding 2% target.
Fed Chairman Jerome Powell and other key central bankers say inflation figures that have risen are about reopening bursts and comparisons to data gathered during pandemic-driven lockdowns. They add the figures will be "transitory."
As the economy recovers faster than expected, the government will pay enhanced unemployment benefits until September, child care remains an issue, and big employers such as Amazon.com raised starting wages to $15 an hour. Other companies are scrambling to hire, with some offering sizable signing bonuses for everything from pizza-delivery drivers to truckers and dental hygienists.
"I don’t know where all the unemployed people are," Procopio says. "It’s almost impossible to hire."
The difference between reported price inflation and the experiences of consumers and businesses is a signal to investors that inflation is hotter than it looks.
Implications of the disconnect are vast, affecting investment returns, inflation expectations, and interest rates, not to mention Social Security payments, tax-bracket adjustments, and economic growth calculations.
“All you have to do is open up your eyes to see there is inflation pressure everywhere,” says Ed Yardeni, president of Yardeni Research. “We are in stimulus shock.”
Yardeni points to the 26% year-over-year increase in M2 money supply, the largest gain since 1943, as fiscal spending in response to the pandemic has topped $5 trillion.
M1, or very liquid money in circulation, is up by 316%. The Fed, meanwhile, has shown no signs of slowing the $120 billion in monthly purchases of Treasuries and mortgage-backed securities that it began in response to the pandemic.
It is possible the Fed is right, and soaring prices in everything from lumber to labor will drop once COVID-19 fades. Inflation, at least as measured, could return to being as elusive as it was in the prior decade after a quarter or two — especially if legislators rein in spending.
But disappointing hiring numbers in April, when the 266,000 jobs added was far below the 975,000 that economists expected, indicated a full recovery is distant.
One feature of the great mid-1960s to early 1980s inflation was a buy-in-advance mentality, Yardeni says, where consumers buy today and reinforce pricing pressures out of fear of higher prices tomorrow. There is evidence that approach is returning.
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