If the Federal Reserve’s view on inflation prevails, a few key things have to go right, particularly when it comes to getting people back to work.
Solving the jobs puzzle has been the most vexing task for policymakers in the coronavirus pandemic era, with nearly 10 million potential workers still considered unemployed even though the number of open positions available hit a record of 9.3 million in April, according to the latest data from the U.S. Labor Department.
There’s a fairly simple inflation dynamic at play: The longer it takes to get people back to work, the more employers will have to pay. Those higher salaries in turn will trigger higher prices and could lead to the kinds of longer-term inflationary above-normal pressures that the Fed is trying to avoid.
The pace of inflation is of critical importance for economic trajectory. Inflation that runs too high could force the Fed to tighten monetary policy quicker than it wants, causing cascading impacts to an economy dependent on debt and thus critically tied to low interest rates.
Consumer prices increased at a 5% pace year over year in May, the fastest since the financial crisis. Economists, though, generally agreed that much of what is driving the rapid inflation surge is due to temporary factors that will ease up as the recovery continues and the economy returns to normal following the unprecedented pandemic shock.
That’s far from certain, though.
The Atlanta Fed’s gauge of “sticky” inflation, or price of goods that tend not to fluctuate greatly over time, rose 2.7% year over year in May for the strongest growth since April 2009. A separate measure of “flexible” CPI, or prices that do tend to move frequently, increased a stunning 12.4%, the fastest since December 1980.
Markets betting on the Fed
Indeed, markets aren’t expecting much movement at all in policy.
Treasury yields actually have dropped since Thursday’s hotter-than-expected consumer price index report, and market pricing now points to no rate hikes until about September 2022 and a fed funds rate of just 1% through May 2026.
A report Friday from the University of Michigan also showed consumers are lowering their inflation expectations, with the year-ahead outlook at 4%, down from 4.6% in the last survey, and at 2.8% over five years, down from 3% though still well above the Fed’s 2% target.
“For all the fears that the Fed will be prompted to tighten policy early to curb inflation, we suspect officials will be just as worried about a slowdown in the recovery in real activity,” wrote Michael Pearce, senior U.S. economist at Capital Economics.
Reference: CNBC
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