Fed risks tapering surprise, stock market shock as central bank’s inflation forecast not ‘credible’, says Wharton’s Jeremy Siegel

Jeremy Siegel, Russell E. Palmer Professor of Finance at the Wharton School of the University of Pennsylvania in Philadelphia, on an interview on December 30, 2014.
Jeremy Siegel, professor of finance at the Wharton School of the University of Pennsylvania.

Wharton finance professor Jeremy Siegel said he does not think the Federal Reserve’s inflation outlook is “credible,” and believes the central bank risks scaling back its monetary policy sooner than expected.

This, he told CNBC Friday, will shock the stock market in early 2022.

“I look at these inflation forecasts that the Fed put, I don’t find them credible at all,” he said, referring to the central bank’s 4.2% target this year and its 2.2% target next year. “We’re going to have much more inflation.”

He continued: “When you see worse inflation, the Fed is going to be pressured and that’s going to disturb the market and that’s down the line.”

Siegel added the US economy can expect “a couple more” bad consumer price index reports towards the end of the year. But in the next two months, he said “the road looks clear” since the Fed will be continuing with its program.

“Powell opened the door saying, if things get worse, we will have to taper faster,’ Siegel told CNBC. “If that happens toward the end of the year, that would rattle the market.”

Siegel also called on the central bank to be more aggressive in containing inflation. He did note that there is not much the Fed can do when it comes to controlling rising prices. Attempting to do so, he noted, will “trouble” the market and the economy.

“I worry actually about an overreaction. Because a lot of that inflation that we’re going to have, I think it’s already there in the pipeline,” Siegel told CNBC. “The Fed can’t really do anything about it.”

The outlook from the Federal Open Market Committee meeting that concluded on Wednesday indicated that tapering asset purchases may “soon be warranted.” Half of the Fed officials expect the first rate hike to arrive by next year.

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Wharton professor Jeremy Siegel says ‘ultimate real assets’ including stocks are his preferred inflation hedge

Jeremy Siegel Wharton CNBC
  • Wharton professor Jeremy Siegel says stocks, among other “real assets,” are his preferred inflation hedge.
  • He also said he thinks prices of goods will be 20% higher than they were prior to the pandemic.
  • Like other prominent figures, Siegel said the Federal Reserve is behind the curve in tapering assets.
  • Sign up here for our daily newsletter, 10 Things Before the Opening Bell.

Wharton professor Jeremy Siegel on Monday offered investors some financial advice for handling an inflationary environment: invest in stocks.

“Stocks are ultimate real assets,” he told CNBC on Monday. “There’s going to be bumps along the way – what I call taper tremors – but ‘there ain’t no alternative’ reigns more now than it ever did before.”

The renowned author of the investment book “Stocks for the Long Run” said timing the market can be difficult but pointed to its cyclical nature.

“It’s like people say, ‘Is there going to be a bear market in the next five years?’ And I say, yes. ‘Should I get out now?’ No, because it could go up 50% before it goes down 20% or 10%,” Siegel told CNBC.

He added how market corrections are inevitable but not before the stock market goes up “much more,” which, he said, happens often.

“Remember, the money supplies last year increased by more than any other year in the last one and a half centuries … that’s gotta be followed by inflation,” he told CNBC.

This is why Siegel thinks prices of goods will be 20% higher than they were prior to the pandemic.

“That’s still nothing like the ’70s and no double-digit, no hyperinflation, but it is going to be something that is a lot more,” Siegel told CNBC. But “you don’t want to be in cash, and you don’t want to be in bonds, and you don’t want to be in money assets.”

Like other prominent figures, including Allianz and Gramercy advisor Mohamed El-Erian, Siegel said the Federal Reserve is behind the curve in tapering assets.

Still, in the event that the central bank does respond to pressures and tapers faster than the widely expected range of late 2022 to early 2023, he will still keep his equity investments.

“Maybe they’re going to start raising in 2022. But still, who is afraid of a 1% Fed funds rate when inflation is 7%?” Siegel told CNBC. “I want real assets. I want land. I want property.”

The central bank slashed rates to historic lows at the start of the pandemic to stimulate economic activity and has signaled its intention of keeping interest rates unchanged until 2023.

Read more: Bank of America says these 29 stocks are its best picks in the top-performing investment style for small companies right now

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What is inflation, and when should you really start worrying about it?

GettyImages 1002925420
Some investors worry that fiscal and monetary stimulus will drive up inflation.

  • Inflation rose 0.5% in July, matching estimates and slowing from the 0.9% jump seen in June.
  • Where most expect inflation to be temporary, others fear a dangerous spiral, or “runaway” inflation.
  • Here’s what you need to know about inflation, where it stands, and when you should start to worry.
  • See more stories on Insider’s business page.

After decades of weaker-than-expected price growth, America has inflation on the brain.

Inflation – or the general rate at which prices climb – has taken center stage as the US economy climbs out of its year-long slump. Economists expected the combination of a swift reopening and trillions of dollars in stimulus to lift prices at their fastest rate in recent history, and inflation soared to its fastest rate since 2008 in the spring. Yet the latest reading suggests stronger inflation is already easing. The Consumer Price Index rose less in July than in the month prior, and several drivers of faster price growth – used cars and some food like beef and pork – cooled.

For some, forecasts of stronger inflation bring up memories of the 1970s and 1980s, an era sometimes called the Great Inflation, when prices grew at such a furious pace that the Federal Reserve had to lift interest rates to historic highs.

For younger observers, healthy inflation is a long pursued but seldom seen goal. Price growth has trended below the Fed’s 2% target for most of the past quarter-century. People under 40 simply don’t know a world with runaway inflation – or what the beginning of such a world might look like.

But recent economic headlines – supply shortages, troubles in the labor market, and big-government programs – have a distinctly ’70s flair. Just when should Americans know when to be really worried that inflation could be back in a big and problematic way?

Here’s a look at what inflation actually is, why it’s a tricky concept that is a bit of a self-fulfilling prophecy, and how it’s actually unfolding in 2021.

Table of Contents: Masthead Sticky

Why are people worried about inflation?

The basic notion of soaring prices is concerning. Roughly 8.7 million Americans are still out of work, and millions more were unemployed for at least some of the past year. At a time when many Americans are looking for stable financial footing, people are more worried about inflation than they have been in years.

The way in which prices have been climbing has already made some worried. While the Fed and President Joe Biden’s Council of Economic Advisors have repeatedly said they expect stronger inflation to be only temporary, others are less optimistic.

Former Treasury Secretary Larry Summers, one of the loudest voices raising concerns of rampant price growth, castigated Democrats’ $1.9 trillion stimulus in March as the “least responsible” fiscal policy in 40 years and kindling for an inflation crisis.

“I think there’s about a one-third chance that the Fed and the Treasury will get what they’re hoping for and we’ll get rapid growth that will moderate in a non-inflationary way,” he added.

A return to the inflation seen in the 1970s would be disastrous for the already ailing economy. In that decade, swaths of easy money were initially viewed as a way to combat unemployment, but inflation quickly broke out of its trend and spiraled out of control. The Fed was forced to step in with interest rates as high as 20% to choke off the price growth, and that had its own detrimental effects on the economy, including a deep recession in the early 1980s.

Conservative economists have warned Biden’s $1.9 trillion stimulus package was unnecessary and could spark a similar disaster. Whether price growth stays elevated or trends back to about 2% will tell the tale of whether Biden’s plan was safe or fuel for a 1970s-like crash.

What would healthy inflation look like this year?

The Fed, America’s central bank, has an “inflation target,” which it uses to guide price growth. In a major shift, the central bank replaced its 2% target in August with a goal for inflation that averages 2% over time. This update allows the Fed to pursue inflation above 2% immediately after the crisis as it tries to run the economy hot and drive a stronger recovery.

The Fed’s own projections point to the stronger-but-transitory inflation it expects to see over the next few months. Policymakers expect year-over-year personal consumption expenditures – the Fed’s preferred inflation measure – to reach 3% this year before cooling to 2.1% in 2022, according to a June release.

The Fed’s new inflation target opens the door for a period of economic overheating as the country reopens. It’s this gamble that concerns conservative economists, or “hawks.” After decades of not letting inflation trend above 2%, it’s embarking on an experiment to let the country run hot in hopes of a faster recovery.

Fed Chair Jerome Powell has been less exact with his forecast, but expects inflation to trend above 2% for “some time” before falling in line with the central bank’s long-term goal.

How does inflation look now?

Signs of an inflation pick-up emerged in the spring, but the latest prints suggest price growth could already be cooling off.

The Consumer Price Index showed prices climbing 0.5% from June to July, matching the consensus estimate and slowing from the 0.9% jump the month prior. The core CPI gauge – which strips out volatile food and energy prices – rose 0.3%. That fell short of estimates and was the smallest increase since February.

Separately, the PCE price index jumped 0.5% in June, exceeding forecasts and showing a rebound in price growth from May’s pace. The measure also notched a 4% year-over-year gain, the fastest annual rate since June 2008. PCE prints lag CPI reports but are preferred by Fed policymakers.

Still, the comparison is somewhat skewed by last year’s weak readings. Inflation “doves” say such a big jump is only natural after the pandemic and widespread lockdowns brought price growth to a near crawl.

Inflation expectations are also a gauge worth watching. Median US inflation expectations for the next 12 months held at 4.8% in July, according to the Federal Reserve Bank of New York. Expectations can serve as a kind of self-fulfilling prophecy. When Americans anticipate faster price growth, businesses tend to lift prices and workers in turn demand higher wages. While inflation expectations typically surpass real inflation, they can hint at the direction inflation will trend, and even affect prices and wages in that direction.

What can the Fed and the government do about inflation?

Inflation has been half of the Fed’s dual mandate since its inception in 1913. The central bank was tasked by Congress to ensure stable price growth for the US economy. Its main lever for doing so is its benchmark interest rate, which dictates borrowing costs across the country.

When rates are high, Americans are more incentivized to save money. When rates are low, or near zero as they are today, Americans are pushed to borrow and spend. The Fed’s ability to change rates allows it to stimulate economic activity in times of recession or cool spending when the economy is running hot.

The latter is primarily how the Fed dampens strong inflation. By raising interest rates, the central bank weakens the incentive to borrow and spend. That then drags on demand and weakens the rate at which businesses lift prices.

Powell said in March that lifting its threshold for future rate hikes can allow it to more aggressively pursue its maximum-employment target.

“There was a time when there was a tight connection between unemployment and inflation. That time is long gone,” he said. “We had low unemployment in 2018 and 2019 and the beginning of ’20 without having troubling inflation at all.”

During those years, unemployment and wage growth among low-income households and racial minorities started to fall in line with broader measures. By letting inflation run above its historical average for some time, the Fed aims to foster not just a tighter labor market, but one that’s more inclusive and beneficial for all Americans.

The risk is that higher inflation in pursuit of a more inclusive economy can spark a new crisis as price growth runs out of control.

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US stocks edge higher as investors weigh comments from Fed officials on the prospect of tapering

Traders work on the floor at the New York Stock Exchange in New York, on July 29, 2021.
  • US stocks edged higher on Tuesday as investors weighed recent comments from Federal Reserve officials on tapering prospects.
  • Atlanta Fed President Raphael Bostic said on Monday that bond-purchase tapering could begin in the fourth quarter.
  • “Everything it seems is now pointing towards the Fed tapering its asset purchases in the coming months,” a senior analyst said.

US stocks edged higher on Tuesday as investors weighed recent comments from Federal Reserve officials on the prospect of asset-purchase tapering.

Atlanta Fed President Raphael Bostic on Monday said the start of a bond-purchase taper could occur in the fourth quarter but did not rule out the possibility of an earlier start if the job market continues to show significant improvements, Reuters reported.

“There’s been a lot to take in these last few weeks; major earnings, a hawkish Fed and some knockout economic readings,” Craig Erlam, senior market analyst at OANDA, said in a note. “Everything it seems is now pointing towards the Fed tapering its asset purchases in the coming months.”

Here’s where US indexes stood shortly after the 9:30 a.m. ET open on Tuesday:

Read more: A 20-year-old crypto market-maker who skipped college breaks down his Reddit-inspired approach to trading – and outlines why he sees ether displacing bitcoin as the ‘king cryptocurrency’

On Tuesday afternoon, Cleveland Fed President Loretta Mester will discuss inflation risks.

In cryptocurrencies, the US Senate rejected a crypto-tax amendment to the $1 trillion infrastructure bill that triggered a battle between lawmakers over which crypto brokers should be subject to new tax-reporting rules.

AMC Entertainment soared after reporting a narrower-than-expected loss in the second quarter. The company also revealed plans to accept bitcoin as payment for movie tickets and concessions at its US locations by the end of this year, CEO Adam Aron said in an earnings call on Monday.

Oil prices rose. West Texas Intermediate crude was up as much as 2.4%, to $68.05 per barrel. Brent crude, oil’s international benchmark, climbed 1.9%, to $70.34 per barrel, at intraday lows.

Gold meanwhile slightly slipped as much as 0.5%, to $1,721.08 per ounce.

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Mohamed El-Erian says the Fed should be tapering already amid inflationary signals – and recommends buying tech stocks in a rising-price environment

Mohamed El-Erian, Chief Economic Adviser of Allianz appears on a segment of "Mornings With Maria" with Maria Bartiromo on the FOX Business Network at FOX Studios on April 29, 2016 in New York City.
  • The Federal Reserve should already be tapering asset purchases amid inflationary signals, Mohamed El-Erian said Monday.
  • “The Fed is late,” he told CNBC. “They are going to be very dovish for very long. They’ve already proven it.”
  • The famed economist also said he prefers to be in the technology sector given the rising-price environment.
  • Sign up here for our daily newsletter, 10 Things Before the Opening Bell.

The Federal Reserve should already be tapering assets purchases amid inflationary signals, Mohamed El-Erian said on Monday ahead of the figures for July CPI due this week. The famed economist also said he prefers to own tech stocks in such a rising-price environment.

“The Fed is late. It should have started tapering already,” El-Erian told CNBC on Monday. “I think the market continues to believe that the Fed will hold out from tapering as long as possible and, therefore, will not raise rates for a while. They are going to be very dovish for very long. They’ve already proven it.”

Given this inflationary setup, the chief economic adviser at Allianz laid out two reasons why he favors tech stocks.

First, he noted that tech companies have proven especially adept at navigating changes in a COVID-impacted environment. Some such examples are Facebook, Apple, and Microsoft, which saw explosive growth during the height of the pandemic.

Secondly, he said these very same firms are less impacted by inflation, and can keep revenues afloat better than any other industry.

“So, they have a revenue advantage and they have a cost advantage, and therefore they have a very strong earnings advantage,” he said.

El-Erian also touched on July’s stellar jobs report, which saw the US economy adding 943,000 payrolls in that month.

“The wage numbers on Friday’s report were really good for the US economy” but were “less good for input costs,” El-Erian told CNBC. “If the inflation proves to be tamed, then you’ve got the Goldilocks.”

A Goldilocks economy, he explained, comes from the combination of both approaches.

“Top-down has been continued ample, predictable liquidity,” he told CNBC. “Bottom-up has been strong earnings, and that has powered the markets through all sorts of things.”

El-Erian did say inflation will eventually “exhaust itself” though on a “much longer timeframe than what the Fed expects right now.”

He’s repeatedly pointed to people’s lack of understanding of how it is already spreading throughout the economy and has countered the Fed’s longstanding narrative that inflationary pressures are temporary.

The central bank slashed rates to historic lows at the start of the pandemic to stimulate economic activity and has signaled its intention of keeping interest rates unchanged until 2023.

Read more: Credit Suisse says buy these 21 growth stocks now as it’s the perfect time for them to thrive while rates fall – and to minimize the risk of losses

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Falling lumber prices show inflation will be temporary – and used car prices will soon follow suit, Fed’s Powell says

lowe's remodeling
A Lowe’s employee stocks lumber inside the home improvement store in New York.

Fed chair Jerome Powell said falling lumber prices illustrate that inflation will prove to be temporary in his press conference Wednesday.

The central bank head acknowledged that inflation data has come in above expectations over the last few months, but said that the data is consistent with the view that the prices that are driving higher inflation are from categories that are being directly affected by the recovery out of the pandemic, like lumber.

“The thought is that prices like that, that have moved up really quickly because of shortages and bottlenecks and the like, they should stop going up. And at some point, they, in some cases, should actually go down. And we did see that in the case of lumber,” Powell said.

Lumber prices have fallen more than 43% since May’s record high of over $1,700 per thousand board feet, although they remain more than 139% higher over the last 12 months, making it one of the best-performing commodities in that time-frame.

Last week, lumber futures fell 18% in the biggest weekly decline for most-active futures in records going back to 1986, per Seeking Alpha.

The Fed chair said used car prices may soon follow Lumber’s trajectory. Used car prices accounted for more than a third of the total increase in core inflation from May’s reading. Powell said a “perfect storm of very strong demand and limited supply” has driven the prices up.

“It’s going up at just an amazing annual rate. But we do think that it makes sense that that would stop and that, in fact, it would reverse over time,” he added.

As for when the trend will reverse, Powell said the Fed is not sure.

“But over time it seems likely that these very specific things that are driving up inflation will be-will be temporary,” said Powell. However, he added that the bank is carefully monitoring the risk of inflationary pressures continue longer than expected.

“And if we see inflation expectations and inflation-or inflation moving up in a way that is really materially above what we-what we would see as consistent with our goals, and persistently so, we wouldn’t hesitate to use our tools to address that. That’s-price stability is half of our mandate, and we would certainly do that,” the Fed chair said.

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Bitcoin rises back above $36,000 as El Salvador declares it legal tender and inflation concerns persist

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Bitcoin has lost nearly half its value since April.

  • Bitcoin rose back above $36,000 Wednesday, boosted by El Salvador’s move to make the cryptocurrency legal tender.
  • Persistent inflationary pressures may have also encouraged investors to add exposure to the digital asset.
  • Once bitcoin breaks through $38,000, it may signal an upward trend towards $47,000, an expert said.
  • Sign up here for our daily newsletter, 10 Things Before the Opening Bell.

The price of the world’s most popular cryptocurrency rose back above $36,000 Wednesday, boosted by El Salvador’s historic move in becoming the first country to establish bitcoin as a legal tender. Persistent inflationary pressures may have also encouraged investors to flock to the asset, which some view as an inflation hedge.

Bitcoin rose to $36,840 at around 1:24 p.m. ET Wednesday, rising 17% from the intraday low the previous day. It has lost almost 50% of its value since hitting an all-time high of nearly $65,000 in April.

“This current market pause is not unexpected. Everyone needs time to assess and digest what the community has built,” Paolo Ardoino, CTO of Bitfinex, a cryptocurrency exchange said. “I’m still extremely bullish in the long term about bitcoin and the long-term fundamentals and use cases of the technology.”

Tim Frost, founder of fintech firm Yield, said if bitcoin can break through $38,000, it may signal an upward trend toward its medium-term average of around $47,000 and potentially beyond.

The congress of El Salvador on Wednesday voted in favor of bitcoin becoming legal tender in the country, cheered on by President Nayib Bukele. Once the law passes through the legislative processes, bitcoin will have the same status as the US dollar – the country’s current national currency.

Bitcoin by then will automatically and immediately be converted into US dollars upon use.

Meanwhile, investors are anticipating US Consumer Price Index data on Thursday, which is expected to show inflation picked up faster than April’s pace, which was already the highest reading since 2008. The European Central Bank will also meet the same day.

Several economists including those at Deutsche Bank have said inflation will make a comeback if the Federal Reserve sticks to its current policy of keeping interest rates historically low.

“We expect inflationary pressures to re-emerge as the Fed continues with its policy of patience,” the bank’s economists on Monday said. “It may take a year longer until 2023 but inflation will re-emerge.”

Beyond these, John Wu, president of Ava Labs, the team behind altcoin avalanche, said that as bitcoin becomes more mainstream thanks to institutional adoption, the more closely it becomes correlated to traditional asset classes.

“Bitcoin was the first crypto to feel this impact and begin to recover,” Wu said. “We’re now seeing it ripple through the rest of the crypto markets.”

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Bitcoin rises back above $35,000 as El Salvador declares it legal tender and inflation concerns persist

2021 03 13T111735Z_1_LYNXMPEH2C07M_RTROPTP_4_CRYPTO CURRENCY BITCOIN TREASURY.JPG
Bitcoin has lost nearly half its value since April.

  • Bitcoin rose back above $35,000 Wednesday, boosted by El Salvador’s move to make the cryptocurrency legal tender.
  • Persistent inflationary pressures may have also encouraged investors to add exposure to the digital asset.
  • Once bitcoin breaks through $38,000, it may signal an upward trend towards $47,000, an expert said.
  • Sign up here for our daily newsletter, 10 Things Before the Opening Bell.

The price of the world’s most popular cryptocurrency rose back above $35,000 Wednesday, boosted by El Salvador’s historic move in becoming the first country to establish bitcoin as a legal tender. Persistent inflationary pressures may have also encouraged investors to flock to the asset, which some view as an inflation hedge.

Bitcoin rose to $35,349 at around 8:14 a.m. ET Wednesday, rising 12% from the intraday low the previous day. It has lost almost 50% of its value since hitting an all-time high of nearly $65,000 in April.

“This current market pause is not unexpected. Everyone needs time to assess and digest what the community has built,” Paolo Ardoino, CTO of Bitfinex, a cryptocurrency exchange said. “I’m still extremely bullish in the long term about bitcoin and the long-term fundamentals and use cases of the technology.”

Tim Frost, founder of fintech firm Yield, said if bitcoin can break through $38,000, it may signal an upward trend toward its medium-term average of around $47,000 and potentially beyond.

The congress of El SalvadorWednesday voted in favor of bitcoin becoming legal tender in the country, cheered on by President Nayib Bukele. Once the law passes through the legislative processes, bitcoin will have the same status as the US dollar – the country’s current national currency.

Bitcoin by then will automatically and immediately be converted into US dollars upon use.

Meanwhile, investors are anticipating US Consumer Price Index data on Thursday, which is expected to show inflation picked up faster than April’s pace, which was already the highest reading since 2008. The European Central Bank will also meet the same day.

Several economists including those at Deutsche Bank have said inflation will make a comeback if the Federal Reserve sticks to its current policy of keeping interest rates historically low.

“We expect inflationary pressures to re-emerge as the Fed continues with its policy of patience,” the bank’s economists on Monday said. “It may take a year longer until 2023 but inflation will re-emerge.”

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What is inflation and when you should really start worrying about it

GettyImages 1002925420
Some investors worry that fiscal and monetary stimulus will drive up inflation.

  • Economists are bracing for the strongest US inflation in decades as the country reopens.
  • Where some expect inflation to be temporary, others fear a dangerous spiral, or “runaway” inflation.
  • Here’s what you need to know about inflation, where it stands today, and when you should really start to worry.
  • See more stories on Insider’s business page.

After decades of weaker-than-expected price growth, America has inflation on the brain.

Inflation – or the general rate at which prices climb – has taken center stage as the US economy climbs out of its year-long slump. Economists expect the combination of a swift reopening and trillions of dollars in stimulus will lift prices at their fastest rate in recent history.

For some, forecasts of stronger inflation bring up memories of the 1970s and 1980s, an era sometimes called the Great Inflation, when prices grew at such a furious pace that the Federal Reserve had to lift interest rates to historic highs.

For younger observers, healthy inflation is a long pursued but seldom seen goal. Price growth has trended below the Fed’s 2% target for most of the past quarter-century. People under 40 simply don’t know a world with runaway inflation – or what the beginning of such a world might look like.

But recent economic headlines – gas shortages, troubles in the labor market, and big-government programs – have a distinctly ’70s flair. Just when should Americans know when to be really worried that inflation could be back in a big and problematic way?

Here’s a look at what inflation actually is, why it’s a tricky concept that is a bit of a self-fulfilling prophecy, and how it’s actually unfolding in 2021.

Table of Contents: Masthead Sticky

Why are people worried about inflation?

The basic notion of soaring prices is concerning. Roughly 10 million Americans are still out of work, and millions more were unemployed for at least some of the past year. At a time when many Americans are looking for stable financial footing, people are more worried about inflation than they have been in years.

The way in which prices have been climbing has already made some worried. While the Fed and President Joe Biden’s Council of Economic Advisors have repeatedly said they expect stronger inflation to be only temporary, others are less optimistic.

Former Treasury Secretary Larry Summers, one of the loudest voices raising concerns of rampant price growth, castigated Democrats’ $1.9 trillion stimulus in March as the “least responsible” fiscal policy in 40 years and kindling for an inflation crisis.

“I think there’s about a one-third chance that the Fed and the Treasury will get what they’re hoping for and we’ll get rapid growth that will moderate in a non-inflationary way,” he added.

A return to the inflation seen in the 1970s would be disastrous for the already ailing economy. In that decade, swaths of easy money were initially viewed as a way to combat unemployment, but inflation quickly broke out of its trend and spiraled out of control. The Fed was forced to step in with interest rates as high as 20% to choke off the price growth, and that had its own detrimental effects on the economy, including a deep recession in the early 1980s.

Conservative economists have warned Biden’s $1.9 trillion stimulus package was unnecessary and could spark a similar disaster. Whether price growth stays elevated or trends back to about 2% will tell the tale of whether Biden’s plan was safe or fuel for a 1970s-like crash.

What would healthy inflation look like this year?

The Fed, America’s central bank, has an “inflation target,” which it uses to guide price growth. In a major shift, the central bank replaced its 2% target in August with a goal for inflation that averages 2% over time. This update allows the Fed to pursue inflation above 2% immediately after the crisis as it tries to run the economy hot and drive a stronger recovery.

The Fed’s own projections point to the stronger-but-transitory inflation it expects to see over the next few months. Policymakers expect year-over-year personal consumption expenditures – the Fed’s preferred inflation measure – to reach 2.4% this year before cooling to 2% in 2022, according to a March release.

The Fed’s new inflation target opens the door for a period of economic overheating as the country reopens. It’s this gamble that concerns conservative economists, or “hawks.” After decades of not letting inflation trend above 2%, it’s embarking on an experiment to let the country run hot in hopes of a faster recovery.

Fed Chair Jerome Powell has been less exact with his forecast, but expects inflation to trend above 2% for “some time” before falling in line with the central bank’s long-term goal.

How does inflation look now?

Signs of an inflation pick-up have emerged, which the Fed says it expected and critics say merits caution.

The PCE price index jumped 0.6% in April, marking the strongest one-month jump since 2008. The measure also notched a 3.6% year-over-year gain, though the data is somewhat skewed by last year’s readings. Inflation “doves” say such a big jump is only natural after the pandemic and widespread lockdowns brought price growth to a near crawl.

The core PCE price index, which excludes volatile food and energy prices, rose 0.7% in April and 3.1% on a year-over-year basis. The core measure is the Fed’s preferred gauge of nationwide price growth.

Separately, the Consumer Price Index showed prices climbing 0.8% in April. The gauge rose 4.2% year-over-year, also indicating the strongest inflation since 2008.

Inflation expectations are also a gauge worth watching. Median US inflation expectations for the next 12 months gained to 3.4% in April from 3.2%, according to the Federal Reserve Bank of New York. Expectations can serve as a kind of self-fulfilling prophecy. When Americans anticipate faster price growth, businesses tend to lift prices and workers in turn demand higher wages. While inflation expectations typically surpass real inflation, they can hint at the direction inflation will trend, and even affect prices and wages in that direction.

Taken together, the gauges show inflation firming, but still far from the peak economists are bracing for. The median estimate for April year-over-year CPI sits at 3.6%, a rate that would be the fastest since 2011.

What can the Fed and the government do about inflation?

Inflation has been half of the Fed’s dual mandate since its inception in 1913. The central bank was tasked by Congress to ensure stable price growth for the US economy. Its main lever for doing so is its benchmark interest rate, which dictates borrowing costs across the country.

When rates are high, Americans are more incentivized to save money. When rates are low, or near zero as they are today, Americans are pushed to borrow and spend. The Fed’s ability to change rates allows it to stimulate economic activity in times of recession or cool spending when the economy is running hot.

The latter is primarily how the Fed dampens strong inflation. By raising interest rates, the central bank weakens the incentive to borrow and spend. That then drags on demand and weakens the rate at which businesses lift prices.

Powell said in March that lifting its threshold for future rate hikes can allow it to more aggressively pursue its maximum-employment target.

“There was a time when there was a tight connection between unemployment and inflation. That time is long gone,” he said. “We had low unemployment in 2018 and 2019 and the beginning of ’20 without having troubling inflation at all.”

During those years, unemployment and wage growth among low-income households and racial minorities started to fall in line with broader measures. By letting inflation run above its historical average for some time, the Fed aims to foster not just a tighter labor market, but one that’s more inclusive and beneficial for all Americans.

The risk is that higher inflation in pursuit of a more inclusive economy can spark a new crisis as price growth runs out of control.

Read the original article on Business Insider

Rent’s big comeback could be the thing that makes stronger inflation permanent

San Francisco apartment tour interior
Manager Justin Sielbach gives a tour of a unit at the 100 Van Ness apartment building on Friday, March 19, 2021 in San Francisco, California.

  • Shelter inflation – which tracks rent prices – is set to boom just as price growth elsewhere cools.
  • The jump could lead inflation to normalize above the Fed’s long-term target of 2%, Morgan Stanley said.
  • Climbing home prices and the end of payment forgiveness will likely drive shelter inflation higher.
  • See more stories on Insider’s business page.

Rent prices tumbled at the start of the pandemic and are only just now on the rise. But where inflation in other pockets of the economy is expected to cool off, rent might just keep climbing.

The Federal Reserve, Biden administration officials, and much of Wall Street see elevated overall inflation eventually moderating as the economy settles into a new normal. The last inflation report, while stronger than expected, showed price growth picking up in services closely linked to reopening. The consensus holds that as such bottlenecks and pent-up demand fade, inflation should moderate, but “shelter inflation,” or rent, could be the big exception to that.

Rent prices are flashing “signs of more persistent inflationary pressures” on the horizon, Morgan Stanley economists said in a Sunday note. Shelter inflation – which covers rent and owners’ equivalent rents – is only just picking up after prices cratered through the pandemic.

Goldman Sachs echoed its peer in a Monday note, saying the “special factors” that held down shelter inflation during the health crisis will soon ease up and drive prices higher.

The shelter-inflation gauge is critical for broader inflation, since it represents “more cyclical, more persistent, and more inertial sources of price pressures,” Morgan Stanley said. And as shelter inflation accelerates through 2021, it could lead broader inflation to normalize above 2%, the team led by Ellen Zentner added.

Shelter inflation
Source: Goldman Sachs

Such an outcome could be worrisome for the Fed. The central bank has said it aims to let inflation run above 2% for some time before looking to pull it back to that threshold for the long term. Inflation settling above that level could force the Fed into an unforeseen corner.

Forecasts suggest soaring shelter inflation could also push inflation expectations permanently higher. Shelter prices are expected to grow 3.8% year-over-year by the end of 2022, Goldman economists said. Inflation will accelerate further and land above 4% in 2023, exceeding the highs of the last economic expansion.

With renters making up nearly one-third of the housing market, such strong inflation could spark intense price concerns. Elevated inflation expectations can drive real inflation higher, as businesses tend to raise prices and workers ask for higher wages when they expect price growth to accelerate.

Skyrocketing home prices could add to the sector’s price pressures, the team of Goldman economists led by Jan Hatzius said. A historic shortage of home inventory and surging demand led home prices to climb at their fastest-ever rate in February, according to the Federal Housing Finance Agency. Although home prices don’t directly affect shelter inflation, Goldman found that 5% to 15% of home-price growth eventually spills over into shelter inflation.

To be sure, shelter inflation counts for just 20% of the core Personal Consumption Expenditures index and 40% of the core Consumer Price Index, two of the most popular broad inflation gauges. It would take considerably strong shelter inflation to pull both indexes to worrying levels.

Still, the component is one to watch as the country reopens, Goldman said. The end of pandemic-era payment forgiveness will likely skew data later this year, as will a tighter labor market. If those factors can fuel stronger shelter inflation expectations, broad inflation could follow.

Read the original article on Business Insider