US cementing higher inflation regime
With most of the Fed’s top brass now focused on the labour market, it appears that many policymakers are not overly concerned about inflation
WITH the exception of goldbugs, almost everyone seems to have abandoned their inflation worries. The Federal Reserve is easing again, Wall Street stocks and bonds are rising in tandem, and even the bruised US dollar has perked up a bit.
The Fed’s strict 2 per cent inflation target seems to be a thing of the past.
And yet financial markets are chattering about a US economy about to be run “hotter”, an investment super-cycle that could extend for years and supply chain disruptions that could reverberate till 2026 and beyond.
Unless artificial intelligence magically blows up all those potential bottlenecks, we are likely to see inflation heat up too.
The extent to which households and businesses seek recompense for these price increases, insurance against them or even seek electoral retribution is an open question.
But one thing is clear: The US inflation regime is in a very different place from where it was before Covid-19 hit.
Friday’s (Oct 24) release of the September US consumer price index (CPI) report will provide a rare piece of economic clarity amid the official data outage that has accompanied what is now a 21-day government shutdown.
Even though the Fed’s leading lights appear to have convinced themselves that tariff-related price rises will just be one-off blips, the CPI update is likely to make uncomfortable reading.
The consensus forecast is for headline inflation to top 3 per cent for the first time in well over a year, marking a fifth straight month of annual inflation gains. That would put both headline and “core” inflation more than one percentage point above the Fed’s 2 per cent target, raising the question of whether it is still a target at all.
Regime change
Even if you assume the tariff impact on prices will be “transitory” – itself a faint echo of the Fed’s much-criticised view on the initial post-pandemic inflation burst – the price pressure hits in what some economists assume is a structurally higher-inflation economy.
Fernando Martin at the St Louis Fed wrote last week that an updated analysis of national inflation trends suggests the United States may now be in a “persistent above-target regime”.
On one level, that is uncontroversial and easily observable.
Headline inflation was below target for 90 per cent of the nine years between when the Fed formally adopted its 2 per cent goal until March 2021, with the Fed’s favoured gauge of price increases, “core” personal consumption expenditures (PCE) inflation, above 2 per cent for just four months. Both measures have been above 2 per cent ever since.
What that means for households is that prices are about 20 per cent higher on average than before the pandemic, a factor that played a big role in last year’s US presidential election.
Martin divides up the past 13 years into three periods, showing average inflation averaging 1.5 per cent from 2012 to 2020; 5.5 per cent during 2021 to 2022; and now 2.7 per cent from 2023 to 2025.
“Arguably, we are now in a situation that mirrors the pre-pandemic era, with inflation moderately but persistently above the target,” he wrote, adding that more than half of consumption expenditures are still on products experiencing annual inflation of 3 per cent or more.
What is more, the distribution of price moves is still skewed to the upside despite inflation easing from recent peaks.
Inflation expectations, whether market or survey-based, are also clearly higher than pre-pandemic readings, now sitting in the 2.4 to 3 per cent range. Many Fed officials still characterise this as “anchored”, or close enough to 2 per cent that it makes no difference.
Indeed, Fed board member Chris Waller – tipped by some to be the next Fed chair – opined last week that inflation is basically at target, and even floated the idea that an inflation range, rather than a point target, should now be considered.
With most of the Fed’s top brass now focused on the labour market, it appears that many policymakers are not overly concerned about inflation that is within a point or so of 2 per cent.
That is a curious asymmetry when compared with the Fed’s seeming obsession with slightly undershooting its inflation target before Covid-19 hit, which resulted in years of near-zero interest rates and repeated waves of bond buying.
But consumers and businesses might not feel the same way.
The purchasing power of US$1,000 today would be reduced to US$820 in 10 years’ time under a steady 2 per cent annual inflation scenario. It falls to US$744 in a 3 per cent regime.
Can the US “eat” that without households demanding higher wages or businesses seeing purchases slump? Maybe, but no one is 100 per cent sure. REUTERS
