On Friday, in response to a reader comment, I noted that the archetypal American Everyman doesn’t keep track of market-based measures of inflation expectations.
That’s not to suggest Everyday Joe (or Plain Jane) is financially illiterate. He (or she) might be, but when it comes to inflation expectations, there’s a sense in which anyone who follows market-based indicators is almost by definition less aware than the average person. If you’ve got a Bloomberg terminal, the odds you’ll notice a 5% increase in your grocery bill are very low, whereas a family of four persisting on an annual income of, say, $60,000, will notice it almost immediately.
The American Everyman scarcely needs to read the financial press. He doesn’t own much in the way of stocks and he knows better than anyone when the cost of living is rising. When it comes to expectations, his social circle is likely comprised of similarly situated people (economically speaking) who might all be fretting about higher gas prices and (I don’t know) expensive chicken wings. By contrast, anyone with a Bloomberg terminal likely socializes with people for whom grocery prices are mostly irrelevant. If you’re buying Chilean sea bass at Whole Foods instead of chicken breasts at Walmart and it’s not a special occasion, you’re out of touch.
Some of us have been on both sides of that equation in our lifetimes. Once you end up on the “right” side of it, it’s imperative you don’t slip into something like blissful aloofness. I try my best in that regard.
In the simple figure (above) I used the same chart header Bloomberg used last week. Expectations do matter, especially when it comes to inflation, and as I never tire of reminding folks, market participants and the media have a tendency to slip into what, at best, can be described as a hall of mirrors. At worst, you might call it a reality distortion loop, depending on the context.
One issue in a hyper-connected, headline-driven world is that word spreads fast, for better or worse. If the word in the financial press is “inflation,” and that starts trending on social media, it can reinforce existing expectations among regular people, who are already noticing real-world inflation at the pump and at the grocery story.
Meanwhile, the Fed, facing a veritable cacophony of criticism from a growing list of high-profile industry names, could be compelled to acknowledge the apparent overshoot in market-based measures, adding fuel to the fire as soundbites feed the narrative, reinforcing the public’s perception that inflation is on the brink of accelerating. At that point, consumers could begin to pull their purchases forward. That’s when the dominoes start to tip.
“We must have an appreciation not just for the realization of inflation but in how the anticipation of it and uncertainty around it impact inflation risk premiums,” Macro Risk Advisors’ Dean Curnutt wrote Friday. “This is very important because at some point the Fed cannot ignore the discovery of prices in real time, it’s ‘wait and see’ strategy notwithstanding.”
Curnutt went on to note that “the prices help satisfy the market’s (almost insatiable) need for narratives [which] serve to reinforce the broad market consensus.” As alluded to above, that becomes an echo chamber of sorts — a merry-go-round. “In circular fashion, what we think helps determine prices, which in turn tell us what to think and what to believe,” Curnutt added, before suggesting that, when faced with rapidly rising breakevens, the Fed could become “uncomfortable,” especially if the price-narrative carousel ends up multiplying “the already prominent chorus of professionals asking the Fed to keep its options open during a period of uncertainty.”
That’s why market prices (and market-based measures of expectations) matter. Set against the first hard evidence of surging prices (figure below), the dynamics outlined above could make the Fed’s “whites of their eyes” approach to tightening and inflation increasingly untenable.
“The longer the Fed ignores the real time price discovery of inflation risk premium, should it reach a further elevated level, the more out of step it could conceivably be if it turns out the Fed’s hopes for transitory are not fulfilled,” MRA’s Curnutt said. “Imagine the scenario in which expectations feed into price so strongly that the absence of tightening action from the Fed becomes a de facto ease.”
That’s a good point. And that perception among markets would invariably exacerbate the situation, further feeding the narrative machine and thereby the media frenzy which, in turn, affects consumer psychology. That’s the nexus between market expectations, consumer expectations and real-world, hard data.
One final consideration: By insisting they “have the tools” and “won’t hesitate to act” in the event realized inflation spikes and remains unduly high for a sustained period, the Fed may have effectively reduced its optionality.
Although policymakers invariably describe the prospect of spiraling inflation as “unlikely,” they seem to view it more as an impossibility. They’ve pre-committed to quite a lot on the dovish side, but they’ve also pre-committed to aggressive tightening if the experiment goes awry.
The assumption seems to be that the implicit threat (i.e., “We’ll go full-Volcker if we have to”) is enough on its own to prevent the situation from getting out of control.
But inflation is a phenomenon, not some self-aware being that can be kept at bay with threats. It can’t “hear” the Fed, and contrary to various mythologizing, “taming” inflation wouldn’t be some knight-versus-dragon clash that everyone would have the luxury of observing from the sidelines. Instead, it would likely be a long, painful exercise complete with all manner of collateral damage for the economy.
In the meantime, Wall Street and Main Street may continue to intersect on this issue. “Some of these market readings – like breakeven inflation – can feed back into investor psychology as they confirm the stories about milk and chicken prices we see on the local nightly news,” Curnutt added.
The investor class looks to breakevens for confirmation of anecdotes from the milk aisle. For the folks wandering down that aisle, the confirmation is right there on the price tag.
Again you are making me nervous. In these pages not so long ago you averred that hyperinflation was not possible in a developed economy such as ours and at least seemed to imply that serious inflation is extremely unlikely. But now you seem to be bringing in the effects of an inflamed media or out-of-control social media responses to Average Joe accidentally becoming informed. Throw in Tucker Carlson, Rick Santelli, and Joe Kiernan shooting the breeze and who knows what will happen?
I don’t steer away from discussing possible economic outcomes just because they don’t happen to line up precisely with what I think is the most likely set of eventualities. Put differently, I don’t try to beat reality into submission just so I can claim to be absolutely correct 100% of the time. That’s the purview of a lot of other sites, but not this one.
I sometimes use your blog to syntesize the clack going on with the chattering classes on the market. OMG, we have some prices going up in a rebound after a generational deflationary shock! Look, both supply chains and demand changes (ie. the market basket for consumers and businesses) is undergoing rapid changes. The Fed is nicely trying to say that there are gigantic mismatches between supply and demand in many goods and services. Until the economy sorts this out, including in the labor market, it is really hazardous to look at the numbers and draw definitive conclusions. There are going to be layoffs in white collar sectors too that were previously left alone during the pandemic as management did not want to rock the boat during a downturn. You can almost bet that the economy is going to pass through some tectonic changes in the next 12-18 months. What I am tryinig to say is that perhaps there could be some inflation that is persistent. But it is probably more likely that there will be some rearranging of the deck chairs and to say that there is a generalized inflation that is consistent is jumping the gun by a far stretch. Gasoline prices are a prime example- Colonial Pipeline is back online. Will gas prices rise from here? Maybe- but they might have already peaked for the summer, and refiners are going to be producing flat out now and shipping gas like crazy. You will be seeing this in some other markets too I would bet- anyone want to say lumber prices are going to rocket more. I will take the other side of that bet. We are likely to be looking at a whole new world this time next year….
My additional predictions for deflationary trends-
Many women, typically the lower earnings contributor, in 2 wage households with kids, will not return to work. For what I think is a meaningful subset, after consideration of childcare, additional food costs (too tired to cook), clothing/personal grooming costs, auto/transportation costs and personal purchases (because they felt entitled given how difficult their life was – balancing work, household and child duties) will realize they brought too little home on a net basis to make it worth going back to work. The big winners (normally) are the children, unless the mother was psychotic. This is deflationary.
Young people (20’s- 30’s) who got a boost in savings will continue to save. After seeing how underprepared their parents were for retirement- they are much more aware of the concept of saving at a much earlier age. This is deflationary, too.
Young people will stick with their pets, forgoing children- this is deflationary, too. Kids are very expensive.
Many entry level, hourly jobs will continue to be replaced with screens. If you compare how European ski resorts are run compared to US- a lot more “self service”/online purchasing of services. Remember when travel agents booked airline tickets for us? Ordering on a screen, even breakfast at a hip restaurant in Denver (I don’t live there, but look forward to returning after I am no longer paranoid to leave the house—and I am fully vaccinated) can be on an Ipad. If the US can’t deliver enough unskilled labor- this will sort itself out with time. This is deflationary, too.
Hardly anyone addresses the “deflationary” possibilities. Sure, there will be some inflationary issues, but many of these will get sorted out with more supply added or retooling the existing delivery process. For example, I doubt lumber is forever going to be this costly. Even if it is, the manufacturing of housing will trend to pre-built in a factory.
As the father of two kis in their late ’20s, I like this one a lot:
“Young people (20’s- 30’s) who got a boost in savings will continue to save. After seeing how underprepared their parents were for retirement- they are much more aware of the concept of saving at a much earlier age. This is deflationary….”
And this one is not trivial:
“Young people will stick with their pets, forgoing children – this is deflationary, too. Kids are very expensive.”
While i agree with the deflationary comments above, supply chain disruptions, pent up demand and stimulus are surely inflationary. I for one have no idea where that leaves us.
The question is simplified into propensitity to save, which has gone up over decades as labour share has decline, big companies have become near monopolies which not only don’t have a lot of workers, but the choices to leave one firm to to another is more limited. Which sounds like I am explaining income / wealth inequality phenomenon, but it also is behind savings glut and unless there is a theory as to why the savings glut is going to decline, sustainable inflation is difficult. Now you may say that the shift the fiscal dominance may be a game changer, but how sustainable is this?