Why inflation worries markets and economists

Why inflation worries markets and economists

When inflation began to accelerate in 2021, price pressures were related to the pandemic: companies could not produce cars, sofas and video games fast enough to meet the demand of consumers confined to their homes, due to interruptions in the supply chain.

Posted yesterday at 7:00 am

Joanna Smialek
The New York Times

This year, the war in Ukraine has caused fuel and food prices to skyrocket, exacerbating price pressures.

Now, with these sources of inflation showing early signs of weakening, the question is how much the overall price increase will subside. The answer will likely depend in part on what happens in one crucial area: the labor market.

stop the momentum

Federal Reserve officials are focused on job creation and wage growth as they rapidly raise interest rates to slow the economy and curb rapidly rising prices. Officials are convinced they must rob the economy of some of its momentum if inflation, the worst in four decades, is to return to its 2% target.

They do this by cutting spending, hiring and wage increases, and by increasing borrowing costs. So far, a sharp slowdown has proven elusive, suggesting to economists and investors that the central bank may need to be even more aggressive in its efforts to moderate growth and reduce inflation.

As this week’s data has shown, prices continue to rise. And, even though the job market has slowed down a bit, employers continue to hire at a brisk pace and raise wages at the fastest rate in decades. This continued progress appears to allow consumers to keep spending and could give employers the power and incentive to raise prices to cover their rising labor costs.

An inevitable recession?

Economists say that as inflationary forces accelerate, the risk increases that the Fed controls the economy so tightly that the United States faces a hard landing, which could translate into falling growth and rising unemployment.

It is increasingly likely “that it will not be possible to remove inflation from this economy without a real recession and rising unemployment,” said Krishna Guha, who heads the global policy and central bank strategy team at Evercore ISI and predicted the Fed could curb inflation without causing a recession.

The challenge for the Fed is that, increasingly, price increases appear to be driven by long-lasting factors related to the underlying economy, and less so by single factors caused by the pandemic or the war in Ukraine.

August consumer price index data released on Tuesday illustrates this point. Gasoline prices fell sharply last month, which many economists believe should lower overall inflation. They also believed that recent supply chain improvements would temper increases in commodity prices. The cost of used cars, which contributed heavily to inflation last year, is now falling.

“A very dynamic labor market”

Despite these positive developments, rapidly rising costs for a wide range of products and services helped push prices higher on a monthly basis. Rent, furniture, dining out, and dental visits are getting more and more expensive. Inflation increased 8.3% annually and 0.1% from the previous month.

The data underscores that even in the absence of extraordinary outages, the price of so many products and services is rising now that costs could continue to rise. The base inflation, which excludes the food and fuel prices to give an idea of ​​the underlying trends in prices, is accelerated by atteindre 6.3% in août après avoir baissé to 5.9% in July.

“Currently, inflation has a very large core component that is driven by a very buoyant job market,” said Jason Furman, an economist at Harvard University. “And then in a given month, there may be more or less inflation just because of the change in the price of gasoline. »

He estimated core inflation would continue to rise to around 4.5% and rise even if pandemic- and war-related disruptions stopped driving prices higher.

War-induced inflation and supply chain disruptions not entirely behind the US: Fighting in Ukraine continues and a rail strike that threatened to disrupt critical US transit lines has been averted narrowly on Thursday thanks to a tentative deal. But encouraging signs show that both of these phenomena are beginning to dissipate.

Supply chains began to unravel and prices for oil and some grains fell after soaring during the Russian invasion of Ukraine.

This could pave the way for a steady slowdown in consumer price inflation, which would help determine how far and how fast inflation can come down. The answers to these questions will depend more on the fundamentals.

Rebalance supply and demand

“The most important question for the Fed is not: has inflation peaked? It is: what is the destination? said Aneta Markowska, chief financial economist at Jefferies. She believes it will be difficult to achieve inflation below 4% (double the Fed’s average target of 2%) without a substantial slowdown in the economy and labor market.

“You still have the housing and the labor market, and there’s still a lot of inflationary pressure coming from those two areas, which are very unbalanced,” said Ms.me Markowska.

That is why the Fed, which is meeting next week, is trying to rebalance supply and demand.

Central bankers raised interest rates from near zero in March to a range of 2.25% to 2.5% at their last meeting, and are expected to raise at least three-quarters of a basis point more next week. The Fed’s actions constitute its fastest rate-hike campaign since the 1980s. The goal is to make borrowing more expensive, which in theory will slow consumer spending, allowing supply to rise and encouraging businesses to lower. their prices to attract customers.

In the wake of worrying inflation data released on Tuesday, investors began to speculate that the authorities could make an even more drastic rate hike next week, or that they could push rates higher than expected. the economy.

But if the Fed decides it needs to tighten the economy more tightly in the coming months to meet its targets, as investors are increasingly speculating, that could come at a cost.

Central bankers hoped to slow the economy enough to reduce job vacancies without hurting it to the point of increasing unemployment. Some economists still believe it is possible, given the current unusual situation in the labor market.

However, a series of faster and more drastic rate hikes would increase the risk of a sharp slowdown in growth that would increase unemployment.

This article was originally published on The New York Times.

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