Macro Insights Weekly: Taking stock of the hot US inflation reading
- Strong demand, supply side disruptions, and labour shortage are driving up prices
- We expect core PCE inflation to be around 3% in 2022, on top of an average of 3.2% this year
- Demand would moderate next year, with negative fiscal impulse and Fed policy lift-off
- Supply side disruptions should also ease
- Still, the fixed income market may be too sanguine, with real yields in deep negative territory
Commentary: Taking stock of the hot US inflation reading
US inflation is running hot; the producer price index (PPI) was up 8.6%yoy in October, hovering around the highest print in over a decade. The consumer price index (CPI) was up 6.2%yoy during the same period.
Inflation has also become broad-based; the widely followed core personal consumption expenditure (PCE) index is running at 3.6%, highest reading in decades. Energy and food prices have been a drag for a while, but now, owing to strong demand and myriad supply side disruptions, durable goods prices have begun to firm. Labour shortages are pushing up service charges and wages, which would likely add momentum to prices.
We measure momentum by annualising the latest 3-month over 3-month reading. That analysis suggests that the worst of inflation pressure may be behind us (especially core inflation), but it is still high by historical standards, with major political and macroeconomic policy implications.
The public responds adversely to higher gasoline and food prices, which complicates the political space. Hence the Biden administration is taking measures to ease supply side constraints, from releasing fuel from the US strategic reserves to keeping ports open 24/7. It has also been amenable to scale back the scale of the two landmark legislations in train.
Regardless of the size of the forthcoming stimulus measures, US fiscal impulse will turn negative by 2022, as many of the emergency support measures expire. The Federal reserve will be tapering asset purchases and will be hiking rates in Q4,’22, in our view. With marginal tightness in fiscal and monetary policy in play for next year, and many of the prevailing supply side bottlenecks likely to ease, the outlook for inflation does not look dire, or policy does not seem behind the curve, in our view. We expect core PCE inflation to be around 3% in 2022, on top of an average of 3.2% this year, but that would still leave 10-year inflation in line the Fed’s objective of 2%/year. The risk is the rather sanguine fixed income market, where real yields are too low, in our view.
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