One inflation is not the other

There's a good explanation for why US inflation rates have been so high lately. This does not alter the fact that a temporary inflation bump can indeed be the prelude to a more structural increase.

What will it be? In recent weeks, there have been a lot of conflicting signals about US inflation. The numbers themselves are clear. Compared to 12 months ago, inflation in the United States is over 4%. That is no less than twice the official target level of the Federal Reserve. An increasingly open economy and the prospect of President Joe Biden pouring thousands of billions of dollars into various major projects are fueling the flames.

The growing chip shortage also contributes to this. Consultancy firm Alixpartners calculated in mid-May that the damage to the auto industry could amount to $110 billion. On the other hand, there are also all kinds of reasons to consider why high inflation is only temporary. For example, the inflation figures measure the price level compared to a year ago, when the economy was hit hardest by the corona lockdowns.

Temporary or structural?
The chip shortage and the strange basis for comparison are temporary phenomena. However, they could just be the harbinger of a more structural increase in inflation. If consumers and businesses expect inflation to rise further, they will anticipate this by already charging higher prices and demanding higher wages. This can create a wage-price spiral. In that case, higher wage costs are passed on in rising sales prices, which in turn lead to rising wages.

Whether it comes to that depends to a large extent on what happens in the labor market. For now, there are 8 million fewer Americans in work than at the start of 2020. But that number could quickly decline once the increased unemployment benefits disappear in September and children go back to school or childcare. For the time being, the Federal Reserve is making little move to raise interest rates. From the minutes of the last meeting, it appears that there is not even agreement yet to talk about phasing out all kinds of support measures.

From greed to fear
At first glance, the financial world does not seem too concerned about rising inflation. The interest rate on US bond markets is an important indicator for this. If investors fear that inflation will really become an issue, they will charge a higher fee on their money. There is nothing to notice for the time being. The interest on 10-year bonds of 1,66% is almost at exactly the same level as 2 months ago.

But stock investors are getting a little restless. For example, the volatility index VIX is steadily rising. And CNN's fear/greed index, which measures how much risk investors are willing to take, has gone from greed to fear within a month. In addition, the dollar has fallen 4% against the euro since the beginning of April. As long as inflation fears simmer, the pressure on the US currency could continue.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

© DCA Market Intelligence. This market information is subject to copyright. It is not permitted to reproduce, distribute, disseminate or make the content available to third parties for compensation, in any form, without the express written permission of DCA Market Intelligence.