It's just a matter of keeping things in perspective ..... Yeah, right !



ref :- "Inflation Hits a High Note", The Wall Street Journal, Markets / Heard on the Street


What, Inflation again? 'Fraid so, and apologies for revisiting the subject once more as though it was the only thing affecting markets .... it's not, it just feels that way. But the WSJ piece is just a quickie really and after yesterday's US inflation data gave markets another fright it seems reasonable to have a look at something along those lines.


US Consumer prices rose in April 0.6% from March, and 4.2% over the last 12 months. Some of the greybeards who remember the ravages of inflation rates well into double figures back in the 1970s may shrug their shoulders, but to more recent market participants who have only known stubbornly low inflation -- largely below and sometimes WELL below widespread policy targets of 2% -- these are pretty heady numbers. Some of the rise can be ascribed to rising oil prices, but even core inflation readings (which exclude the unhelpful volatility of food and energy prices) are 3% up from a year ago. If you're an investor looking for a headline to scare yourself, that's the biggest year-on-year rise for 26 years.


But hang on ..... surely last April the world was slipping ever further into the Covid crisis and huge chunks of the US economy were closing down with predictable downward effects on demand and prices. One year on, the country is emerging from the pandemic and a combination of rising demand and inevitable supply chain disruption is bound to give an equally predictable boost to prices. One is tempted to ask those shocked by yesterday's numbers: "Well, what on earth did you expect ?" And their answer would be: "Not 4.2% !"


Actually, the average prediction for annual inflation in April was 3.6%. In normal times, a miss of 0.6% would indeed be a big one but so wild is the pandemic-driven ride we're all on that we reckon we're going to see a lot of estimates miss the mark one way or another over the next few months and people would do well to get used to it. But jittery investors just don't work that way.....


The Fed is pretty calm about it though, or at least that's the message it's trying to convey. They are sticking with the belief that although some chunky hikes in inflation are inevitable, most of that impetus will subside once supply chains get up and running smoothly. They are certainly steering well clear of any suggestion that they will temper their hugely supportive monetary policy on the back of short-term spikes in prices, and not only because of the market havoc that such a suggestion is likely to wreak.


The WSJ article points out that whilst price inflation/deflation is often thought of as merely a function of supply and demand, the Fed is aware of another important driver of inflation rates. One might say it's actually the most interesting element of what is after all a pretty dry topic in that it centres on psychology. If people think that prices will be higher in the future, they will buy now.... and if enough people do it that of course it will drive up prices. So inflation is, in part at least, a self-fulfilling phenomenon. That's what it was like in those 1970's when inflation was so savage that one felt one had to buy whilst one still could, so embedded in public consciousness was the idea of rampant price rises.


Note: the title of the WSJ piece is a reference to the fact that icons like Marvin Gaye were even singing about it -- Inflation Hits a High Note (geddit?) ..... and don't anyone dare ask who Marvin Gaye was!


More recent generations have only known a low-inflation environment when central banks struggle to hit their ideal targets of 2.0%. If people don't expect any significant price rises, then the psychology element ceases to a driver of inflation. Clearly, that's the scenario that the Fed believes we'll revert back to once things are back on an even keel. The big irony is that they wouldn't mind just a little bit of that kind of belief of higher prices in the future to help get inflation up to their desired level of 2%, but that's not easy to engineer and very difficult to control if you do.


Anyway, neither we nor the Fed can be at all sure that the current rising demand -v- supply chain problems issue will correct itself in exactly the manner anticipated. If it gets significantly more acute, any ruminations on the public psyche will not very relevant.

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