Inflation Is Now an Undeniable Reality: Authers’ Indicators

June’s inflation data delivered a third nasty shock in succession. The Fed’s preferred measure of inflation, the Core PCE deflator, is also at its highest level since 1992. Meanwhile, headline inflation (including fuel and food) is at 5% for the first time since the oil price spike of 2008. Producer price inflation is also high. These are sudden moves and the more muted rise in the “trimmed mean” measure, which excludes goods that have suffered the most extreme changes in price, suggests that it is indeed mainly a transitory effect from the pandemic. But it will still be a relief if next month’s data can show a significant retreat in some of the sectors that were hit by extreme inflation.

There is deepening concern over shelter inflation, the single biggest component of the CPI index, which is now up to 2.3% and will likely rise further as higher house prices pull up rents in their wake. This will be particularly closely watched. But the most extreme transitory effects of the pandemic are otherwise beginning to ease. Car rental prices, for example, are now “only” 88% higher than they were 12 months ago, having previously topped 100%. Several sectors which took a deflationary blow from the pandemic are still not seeing prices recover. Recreation inflation is still negative. And — heaven be praised — college-tuition inflation remains close to its lowest since records began in 1979, although it did tick up slightly in June. It is still just about possible to sustain an optimistic narrative that the pandemic caused extraordinary inflation in some pockets of the economy but might have brought sanity to others where prices had grown prohibitive.

The bond market, where traders make their most precise predictions of inflation, has been in flux all year. Four months ago, 5-year breakevens topped 2.75%, virtually matching their high during the 2008 oil price spike. Since then they have dropped below 2.4%, but the latest data brought them back up to 2.6% — higher than they were at any point between 2010 and 2020. Meanwhile, expectations for the years from 2026 to 2031 have fallen to 2.16%, suggesting confidence that the Fed will still be able to rein in inflation over the next five years. The heat map is based on the 20-day moving average of the breakevens, to avoid being too affected by day-to-day movements, which have been violent in the last few weeks. Nobody is positioned for the Fed to lose control of inflation anytime soon, nor for Germany or Japan to snap out of their disinflationary malaise.

These numbers offer perhaps the greatest support for the case that inflation is a near and present danger. The small business survey shows inflation expectations at their highest in four decades, while the Institute for Supply Management numbers are at post-2008 highs and still rising in the latest number produced at the beginning of July — although the survey for the services sector did show a slight decline. Consumer expectations have also risen very sharply, to their highest since the commodity price spike before the financial crisis, with the latest Conference Board survey reaching a fresh high for this cycle. This could be transitory but, if so, the numbers need to come down soon.

Rising commodity prices represent exactly the kind of inflation that can attack living standards. But, given the economic collapse a year ago and the rush by speculators to get a leveraged play on the rebound, they don’t give firm evidence of inflation that is more than transitory. Metals prices have rebounded and are now less than 4% below their May peak. Energy prices, which have enjoyed an uninterrupted rally to double from their low last year, are still more than 90% from their all-time high set in 2008; it’s not clear that this poses dangerous inflationary problems. Meanwhile, the immense rally in lumber prices earlier this year has proved transitory, as widely expected at the time: Prices are down 58% from the peak.

Wage inflation is a crucial driver of inflation and, from the official data, it appears to be under control despite a number of factors that would normally drive salaries and wages upwards. Most measures of wage inflation are running below their average for the last five years, with the Atlanta Fed putting overall wage growth at 3.2%. But job vacancies are at an all-time record, while small businesses complain that they have never found it harder to recruit workers. This suggests a problem with skill mismatches coming out of the recession. Average hourly earnings have been quite variable over the last few months, but the latest number shows them increasing at the fastest rate since 2009. The ongoing wage tracker kept by the Atlanta Fed shows that wage inflation for low-skilled workers has reached 3.6%, close to its highest since the global financial crisis; and the National Federation of Independent Business finds the highest proportion of its members raising pay since they started asking the question in 1984.

Broadly, the consensus is that the Fed, like other central banks, will get what it wants. The Fed is forecasting Core PCE (personal consumption expenditure) of 3% for this year, but expects it to decline to 2% in 2023; in other words, it will be transitory. The experts are less anxious for now and think it will reach 2.5% this year and decline in the two following years — more or less perfect for the Fed, which is prepared to let inflation “run hot.” German inflation, after a bobble this year, is expected to fall back to 1.7% in 2023; there’s no sign of a new reflationary cycle there or in Japan, or even China. Whatever markets say, the experts are still more worried about deflation.