If the price of everything you buy feels soaring, it’s because even central bankers are worried about the risk of deflation.
The gap between everyday experience and the annual inflation rate of 1.3% in August is huge. The prices of the things we buy are rising much faster, while the things we no longer buy are falling, but we still take the figures into account.
Economists will be relieved that the laws of supply and demand still work. But for investors, it’s probably putting a veil on the outlook on the single most important issue in the market: whether we are heading for future inflation, deflation, or the continuation of sluggish price increases over the past decade.
Start with the latest supply and demand. Food costs for families, where many of us spend our time, rose 4.6% year-on-year in August, the biggest increase in nearly 10 years. Food is 3% cheaper in abandoned workplaces and school cafeterias.
Food prices move a lot, but the same pattern emerges for many of the things that are sensitive to us sitting at home in Zoom. Few telecommuters need a new suit or dress (a 17% reduction), makeup (a 3% reduction), a hotel room (a 13% reduction), or a ticket (a 23% reduction).
Fashionable: sitting at home in pajamas (4% increase in men’s pajamas), riding a bike (6% increase in cycling), reading for pleasure (4% increase in books, 5% increase in newspapers), making things (9% increase in sewing machines and fabrics) ) %, camera 4% increase). Health care is in high demand (a 5% increase) and higher education is much less attractive (a 1.3% increase in tuition fees, the lowest since data began in the late 1970s).
The fluctuations in our buying habits highlighted the difference between the Consumer Price Index (CPI) and the Personal Consumer Expenditure Price Index (PCE). CPI captures headlines and determines returns on inflation-related government bonds or TIPS. The Federal Reserve uses PCE, and the two diverged in the summer.
The CPI is assessed based on spending patterns a few years ago, and the PCE recalculates spending every month. The latest PCE data is through July, but on an annual basis, prices have risen 0.4% compared to the previous three months, showing a rebound in three months. As the economy resumed in August, the three-month annual CPI inflation exceeded 3%, but the CPI was still falling in price at that baseline. Considering the method of calculation, the PCE may be higher in August.
The Federal Reserve has promised not to raise interest rates until PCE inflation reaches 2%, so the big money depends on what will happen next. Treasury bonds, stocks, and the dollar all depend on whether the Fed will start raising interest rates earlier than expected or never give it.
The laws of supply and demand explain the difference in inflation between what we want and what we don’t want. The outlook for inflation is also divided into overt inflationary pressures and overt deflationary pressures due to the overall supply and demand. Politics and pandemic provide both.
The apparent inflationary pressure in politics comes from more stimulus measures. Inflation of what we can buy emerged during the pandemic because the government supported demand. Household income has actually increased thanks to federal stimulus and generous unemployment benefits, which are rare in a recession.
Now the consensus is that there is no possibility of other government spending packages before the elections that are worrying the Fed. High unemployment rates generally affect overall demand as household incomes fall, which means inflation is weak (political deflationary pressure).
Since the epidemic limited supply, providing inflationary pressure, prices surged when demand increased (e.g., eating out as closures eased). And because Covid-19 has intensified the US-China trade war and the trend of deglobalization, supply may be limited for a long time.
The epidemic also creates deflationary pressures, hitting demand as people become socially distant, losing jobs and shrinking businesses.
“In the short term, demand shocks will prevail, so we will lower prices over the next 12 to 18 months,” says Luigi Speranza, senior global economist at BNP Paribas. The lasting impact of the epidemic can reduce the need for travel and tourism workers over the years, while those who are unemployed can lose their skills.
Other economists are also concerned that over the long term, urban and commercial real estate will struggle and many workers will find new roles in the transition to working from home and online shopping.
How these various supply and demand pressures will be balanced is far more uncertain at the macro level than at the micro level. If the government and Congress take the Fed’s free money to come up with more stimulus, this summer’s price hike will continue and could be a serious concern for investors.
Similarly, massive job losses and a recession could threaten demand and prices, followed by the third wave of Corona 19. In Europe, the three-month inflation rate dropped to exactly zero in August as a second wave hit Spain and France.
Perhaps the government will proficiently manage the virus and the economy to provide stimulus when necessary and withdraw the appropriate amount to prevent inflation from rising too much. Much more likely it is likely that it will go wrong and end up with too many or too few stimuli.
The test lies in how much inflation we actually get and which part of the economy feels it the most.