Inflation in the US finally breaks away from the word “transitory”

Wall Street is finally getting the message that inflation is not going to go away easily. Although all signs that price pressures were spreading, fantasies dominated the markets for much of May: Bond yields were down, stocks were up, and fortune-tellers were beginning to hint that the Fed might stop rising. interest rates in September. Somehow, the idea that inflation was “transient” never really died, perhaps until now.

That illusion set the stage for Friday’s sharp sell-off in stock and bond markets after a Labor Department report showed consumer prices rose 8.6% in May from a year earlier, a new high. four decades and well above economists’ expectations. With investors having learned their lesson the hard way, there is a risk that inflation expectations will start to rise steadily from now on, creating a whole host of new problems for the Fed.

Five-year breakeven rates, a way of measuring what the market expects inflation to be over the life of benchmarks, rose to the highest level since early May on Friday, while a survey of the University of Michigan revealed that consumer inflation expectations for the next five to 10 years rose to the highest level since 2008. The Federal Reserve Bank of New York will update its survey of inflation expectations next week, and it may give the Fed another reason to become even more aggressive than it has been. Including renewed debate about the need to raise the upper limit of the federal funds rate by 0.75 percentage point at an upcoming meeting, as traders began to consider on Friday. That would be an even bigger hike than the already aggressive 50 basis point pace that markets are expecting for upcoming meetings.

Consumers and markets were not going to be able to keep their heads in the sand on inflation forever, but the stability of long-term inflation expectations had been one of Fed Chairman Jerome Powell’s biggest assets. As frustrated as consumers and traders were, most people had essentially hoped that prices would eventually come down, either on their own as supply chains stabilized or because the Fed raised interest rates. enough to align demand with supply, and probably a mix of both. Policymakers generally agree with rising near-term inflation expectations, but worry that inflation will become a self-fulfilling prophecy as markets and traders begin to expect inflation for the foreseeable future: workers demand wages higher to offset steadily rising costs of living; manufacturers raise prices to offset rising labor costs; and the cycle continues until, as happened in the late 1970s, someone like former Federal Reserve Chairman Paul Volcker ends the cycle with sky-high interest rates, albeit with significant economic consequences. .

It is clear that we are not there yet, certainly, and it is unlikely that Powell will face a Volcker economy. Five-year consumer and market inflation expectations are still well below the 8.6% rate that has baffled the market today. But they do imply a subtly growing conviction that the Fed’s 2% inflation target cannot be trusted, and that could allow the problem to fester.

There will be those who say in the markets that inflation is not as serious as it seems. Economists and market watchers like to ignore the headline figure because it is often largely due to volatile food and energy components and can detract from the underlying trend, which is true, although the fundamental trend isn’t that great either. encouraging, whichever way you look at it. On the other hand, the highest inflation number is the one that best reflects how Americans actually feel price pressure (at the gas pump and in the supermarket) and has the greatest effect on their expectations of inflation. self-fulfilling inflation. The genie is out of the bottle and the Federal Reserve faces a difficult period as it tries to convince the markets and the public that this situation will not last forever.

This note does not necessarily reflect the opinion of the editorial board or of Bloomberg LP and its owners.

This article was translated by Miriam Salazar

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