In the immortal words of Alanis Morissette: Isn’t it ironic that just as policymakers from President Joe Biden to Treasury Secretary Janet Yellen and her successor at the Federal Reserve, Jerome Powell, are all offering apologies for misreading the economic tea leaves, inflation is probably peaking even as I write?
The various and sundry mea culpas, the action plans to fight inflation and the wholesale criticism of policymakers who had virtually no control over the underlying events that caused a spike in consumer prices, may well look pretty silly in just a matter of months.
It just might be that inflation will, in fact, be transitory after all.
And by transitory, I mean a year or two, not a month or two, as many misinterpreted the Fed’s choice of words last year.
If history is any guide, inflation spikes that follow massive disruptive events, like World War I and the “Spanish Flu,” or World War II, last a couple of years before plunging again once supply and demand came back into balance.
History of inflation spikes
I have long argued that this most recent experience with rising inflation (and no, it’s not nearly a record surge), is much more like a post-war experience than it is like the sustained inflation of more modern vintage that truly began to accelerate in 1968 before peaking in 1981.
According to the Minneapolis Federal Reserve, which maintains inflation histories on its web site, post-war inflation spikes were extremely large, but unwound themselves when the world returned to normal.
When the U.S. entered World War I in 1917, inflation surged to a rate of 17.8%, followed by 17.3% in 1918 and then 15.6% in 1919.
Come 1920, inflation plunged, falling by nearly 11% and remaining quiescent for several years hence.
So, too, in the years after WWII, inflation spiked to 8.5% in 1946, 14.4% in 1947, slipping to 7.7% in 1948 and contracting by 1% in 1949.
The extended nature of the global Covid pandemic and subsequent closure of the Chinese economy, coupled with Russia’s largely unanticipated invasion of Ukraine, wreaked havoc on global supply chains, as we well know, disrupting the shipments of both raw materials and finished goods that lasted far beyond any reasonable assessment of conditions on the ground in early 2021.
But we are starting to see some signs of normalization, as China moves to reopen and the world, OPEC included, is taking steps to reverse the adverse effects of Russia’s invasion on both food and energy prices.
Inflation “breakevens,” a measure of bond market expectations of future inflation, have rolled over decidedly.
Measures of core inflation, excluding food and energy, have stalled out.
With exception of energy products, other commodities like lumber, corn, wheat and soybeans, have either crashed, as in the case of lumber, or have begun to roll over in the case of agricultural goods.
Meantime, sticker shock in housing has begun to abate … at least a little bit. More new homes are coming to market while home sellers are reportedly beginning to cut asking prices to bring in more cautious buyers.
Used car prices have moderated and the waiting times for car purchases have begun to decline. Retailers are stuck with bloated inventories as consumers have shifted buying patterns of late, suggesting that retailers may cut prices on goods simply to get them off their shelves.
Companies, still reeling from labor shortages are investing heavily in productivity enhancing technology, from robots to AI programs while layoffs are just starting to rise.
Inflation has peaked, the Fed should react
Very few policymakers are prepared to predict peak inflation, just as they were equally unwilling to better define the notion of transitory in a historical context.
In my humble opinion, inflation has peaked. 2023 prices will fall from current levels.
The Fed, by the end of this year, will have done its job in reducing normalized demand to meet temporarily constrained supply.
I’m betting the Fed does not push the federal funds rate, the short-term rate over which it has the most control, above 2%. I also think Quantitative Tightening (reducing the size of the Fed’s balance sheet) will be a short-lived experiment in further tightening credit conditions.
Monetary policy, as I have argued recently, no longer works with a “considerable lag,” as many suggest.
Interest rates shot up at a record pace in the year’s first quarter while the dollar unexpectedly strengthened further.
Markets, and the real economy, very quickly adjusted to changes both in Fed commentary, and its actions, and wrung a great deal of excess out of domestic, and global equity markets.
Witness the plunge of richly valued, mega-cap tech stocks, or in “meme stocks,” and in cryptocurrencies, their associated exchanges, NFT’s and emerging market investments.
The Fed should pause in September to reassess where the economy is headed now that the economy appears to be slowing and inflation appears, again, in my opinion, to be peaking. There may yet be a summer of discontent on Wall Street, but by autumn I suspect there will be no further fall.
