Making Sense Of The March Inflation Report – Part 2

Economic forecasters seem to think the worst of the inflation surge may have peaked in March. I’m not sure how anyone can make such a prediction given the uncertainty of a possible World War III breaking out in Europe, new Covid variant outbreaks around the world and in the U.S., and accelerating climate change in the world’s temperate zones where much of the world’s food supply is grown.

These Wall Street economists have been spectacularly wrong predicting job growth and GDP growth coming out of the Coronavirus pandemic, and many have been wrong prediciting that inflation would be mild and short-lived. So take this with a large grain of salt.

Politico reports No end in sight for spiking prices? Enter the ‘peak inflation’ crowd:

Consumer prices have soared to their highest level in four decades, but if some of the world’s largest banks are calling it right, the inflation fever that has gripped the country could be breaking.

In recent days, economic forecasters at Deutsche Bank, UBS and Bank of America, among others, have said that the March inflation number — an 8.5 percent surge over last year — may be the worst of it.

The predictions of “peak inflation” could comfort the White House, which has struggled under the political fallout of the consumer price hikes and faces the potential loss of Congress in this year’s elections. Republicans are trying to pin the dismal numbers on Democrats, and they may have a winning issue [Why? Republicans are not offering any plan to voters to deal with inflation, because they have no plan]: Voters, whose paycheck gains are mostly being wiped out by inflation, have consistently told pollsters that price increases are a top concern and given President Joe Biden low marks for his handling of the economy.

Among the banks’ reasons for optimism: Used car prices, which propelled much of the inflation last year, have begun to fall. Supply chain snags should finally fade as the post-Covid economy develops, they say. And the Federal Reserve is poised to aggressively tackle the issue by jacking up interest rates in the coming months.

“Barring further severe disruptions, the March release is likely to be the peak in terms of year-over-year rates for both headline and core given that the base effects from last year’s surge in used car prices will begin rolling off in the April data,” Deutsche Bank analysts wrote in a note to clients this week. Headline inflation refers to all price increases, while the core number excludes volatile food and energy costs.

Skeptics say we’ve seen this movie before. When inflation started raging last year, both Fed Chair Jerome Powell and Biden played down the phenomenon as “transitory.” That wasn’t the case.

The persistence of the virus pandemic, Russia’s shocking attack on Ukraine, and a still gaping mismatch between available workers and open jobs have continued to boost prices on everything from housing to food and fuel, stoking uncertainty about the future. Oil surged after the inflation numbers were released Tuesday, and housing costs haven’t even fully worked their way into the data.

“We have been at this juncture before where subtle shifts within the data make it appear that the level of inflation has reached its peak for the cycle only to keep marching higher,” Charlie Ripley, senior investment strategist for Allianz Investment Management, wrote in a client note. “Going forward, the greater concern is really around how entrenched inflation has become as Americans continue to worry about rising prices.”

The March figure was the highest since the early days of Ronald Reagan’s administration when then-Fed Chair Paul Volcker and the central bank engaged in a scorched earth rate-hike campaign to break inflation during the oil-price shock years, even though it meant sparking a long, painful recession.

Today’s grim inflation numbers have Democrats and their interest groups and economists worried that ever-rising prices will cost them both houses of Congress. Some of them are blaming the problem on Russia, dubbing them “Putin’s price hikes” — even though inflation was rising well before the invasion of Ukraine [due to the global pandemic economic disruption] — and talking up the strength of the U.S. economy.

“Despite these record-breaking economic gains and significant progress to address supply chain disruptions, Russia’s war against Ukraine pushed up prices on food and energy, which accounted for more than 75% of inflation in March,” Rep. Don Beyer (D-Va.), the chair of Congress’s Joint Economic Committee, said in a statement.

Despite the delicate mix of hopes and dreams that the peak inflation school is built on, it’s catching some fire on Wall Street, where no one wants the market party to come tumbling down as it did after the dot-com and housing bubbles popped, causing the last two significant recessions.

Swiss bank UBS analysts wrote: “Over a large part of the past year, UBS’s inflation forecasts were well above consensus expectations on Wall Street. And so far, they’ve been right. Inflation data has repeatedly surprised to the upside, moving to highs many experts—including those at the Federal Reserve—simply weren’t predicting,” analysts recently noted.

But the giant bank added, “Now, UBS is calling its shot once again, arguing inflation will peak in March and move down ‘sharply’ from there as consumers shift their spending to services and used car prices, which have been sky-high throughout the pandemic, begin to drop.”

Said Bank of America: “With market expectations close to our view, the Fed could deliver on our projected path without surprising investors much.” It added, “[R]isks to our Fed forecast are tilted to the upside. If inflation looks like it is heading below 3 percent, then our current call should be hawkish enough.”

Beth Ann Bovino, chief U.S. economist at S&P Global, said the U.S. is “likely near or at the top of the price gains.” But she added that the “Fed has its work cut out for them this year and next year to address inflation.”

Axios reports, Why inflation may have already peaked:

There’s good news and bad news in Tuesday’s inflation report.

• • • The bad news: Consumer prices have risen by a shocking 8.5% over the past year, a rate of increase not seen in more than 40 years.
    • The good news: That number has probably gotten as high as it’s going to get, and could soon start coming down.

What they’re saying: Inflation “has likely peaked,” said Bank of America analysts on Tuesday. Their counterparts at Capital Economics concurred, saying that the 8.5% figure would “mark the peak” for the series.

How it works: The headline inflation figure, which spiked by 1.2% in March alone, has been driven overwhelmingly by energy prices. Core inflation, which excludes food and energy, was relatively subdued, rising only 0.3%.

• • • Good news is likely in the coming April inflation report: The price of oil has fallen to $94 a barrel, down from a peak of $124 on March 8.
    • Gas prices have followed oil prices down. The U.S. average price of $4.08 is down 6% from $4.34 in early March, per GasBuddy.
    • Right now we’re reaching the end of the period in which we’re comparing to prices that were artificially depressed by the pandemic — and we’ll soon be comparing to prices that were hitting artificial highs thanks to global supply constraints.

The other side: Any declaration that inflation has peaked is necessarily “provisional at best,” wrote RSM’s Joe Brusuelas in a research note, given the volatility and unpredictability of oil prices in a time of war.

• • • If Europe stops importing oil and natural gas from Russia for any reason, that alone could send energy prices soaring again.

What’s next: The Fed is going to keep on raising rates all year. The central bank tries to ignore volatile food and energy prices, but core inflation, at 6.7%, is well above the Fed’s 2% target.

• • • Higher interest rates have already started to show up in the mortgage market, where 5% mortgages are now common. That should help slow home-price inflation.

The bottom line: We may be moving from inflation being high and rising, to inflation being high and falling. That’s better, but it’s still not great.

Economist Paul Krugman explains, Inflation Is About to Come Down — but Don’t Get Too Excited: The bullwhip is flicking back. (subscriber content).

Inflation is likely to come down soon, but some of the improvement will be … transitory https://t.co/lE8NrWWfn8

— Paul Krugman (@paulkrugman) April 12, 2022

What is the bullwhip effect?

The bullwhip effect is a supply chain phenomenon describing how small fluctuations in demand at the retail level can cause progressively larger fluctuations in demand at the wholesale, distributor, manufacturer and raw material supplier levels. The effect is named after the physics involved in cracking a whip. When the person holding the whip snaps their wrist, the relatively small movement causes the whip’s wave patterns to increasingly amplify in a chain reaction.

In supply chain management, customers, suppliers, manufacturers and salespeople all have only partial understanding of demand and direct control over only part of the supply chain, but each influences the entire chain with their forecasting inaccuracies (ordering too much or too little). A change in any link along the supply chain can have a profound effect on the rest of the supply chain. Given that, there are many contributors and causes of the bullwhip effect in supply chain management.

Dylan Matthews write a mea culpa at Vox. How I (and US policymakers) got inflation wrong:

Let’s get this out of the way first: I was wrong about inflation.

When prices began ticking up a little faster than normal early last year, I wasn’t overly concerned. I’d been covering economic policy since 2008, and in that whole time (in fact, in my whole lifetime!), the US had never had a problem with excess inflation.

In fact, our main inflation problem was that we had too little of it. The Federal Reserve, which is tasked with managing the money supply to keep inflation steady and unemployment low, set a low inflation target of 2 percent a year, and kept falling short. If there is, as most economists believe, some trade-off between inflation and unemployment, that means the Fed’s policies on inflation were unduly hawkish and kept many people out of work during the long recovery from the Great Recession.

So I wrote a long piece last summer arguing that high inflation was unlikely in the 2020s. When fears arose last fall that rising inflation expectations — that is, people thinking inflation was going to be higher in the future — could in turn lead to more inflation now, I wrote a newsletter citing research that cast doubt on that theory. This January 1, I predicted that average US inflation for the year would be below 3 percent.

Well, in February, core inflation as measured by the personal consumption expenditures (PCE) index grew by 5.4 percent, and seems to still be heating up. That’s my preferred metric, but data released on April 12 showed that the more widely publicized consumer price index grew by 8.5 percent compared to the year before, the highest rate in four decades. The US would be very lucky to keep inflation below 5 percent for the year at this point; my prediction of 3 percent looks, three months later, ridiculous.

At the time I wrote my July 2021 piece, “Don’t worry about inflation,” a prescient copy editor noted that this headline might look bad if I was wrong and inflation got increasingly worse. I responded that I stood by it, and if I was wrong, I would write a groveling follow-up piece.

So here we are.

He then provides a lengthy explanation and a new theory of inflation, which if you are interested you can read his article. His “expectations” theory sounds too much like a wage-price spiral theory to me, which almost no economist would say that we are experiencing right now. Labor does not have the leverage to demand higher wages. Companies are paying higher wages now because there is a labor shortage after so many left the workforce since the 2008 Great Recession and the 2020 Coronavirus Pandemic shutdown. Employers are driving higher wages in order to attract the employees that they need. And employers are increasing prices to cover the higher wages.