While for months the Federal Reserve labeled increasing inflation as "transitory" they've now shifted their position to one, seemingly, of almost panic. Indeed, after being persistently below 3% the last 10 years (and often below 2 or even 1%) the year-over-year rate of change of consumer prices hit +7.5% in January. Driven by surging demand from consumers and businesses for goods and services we're now seeing the highest inflation readings in 40 years. So, should we panic too?
I don't believe so. I believe much of the recent inflation can be explained by supply chain constraints which were driven by the Covid-19 pandemic and accompanying response. As workers get vaccinated (or vaccination and mask mandates are dropped), more materials (and labor) should come online this year. Consider as well that we've kept interest rates at 0% and given away over $3 trillion the last eighteen months. Whether you agree with the response or not, world governments have pumped obscene amounts of money into the system. Stimulus checks, PPP loans/grants, and enhanced unemployment benefits have all now ended with no expectation of return. Furthermore, market participants are now pricing in expectations for multiple increases this year in the Fed Funds rate. This has already pushed the 30 year mortgage rate from under 3% a year ago to over 4% now. A resurgent U.S. Dollar should also serve to reduce the price of imported goods. Lastly, buoyed by the hope of selling at high prices, manufacturers now report expanding their inventories by the highest rate in 20 years.
All-in-all, I believe the indicators are pointing to a quickly cooling inflation situation. With that in mind, I believe inflation readings may be back below 3% by as soon as the end of 2022. What's more, I think the concern may even be shifting back to deflation by then. Painful as today's surging prices are, I don't expect it to last.