Home > Bumpy inflation in the months ahead

Bumpy inflation in the months ahead

November 17, 2020 By Mircea Vasiu

Will the Fed manage to create higher inflation expectations in the period ahead?

Last Thursday, the Consumer Price Index (CPI) in the United States was released. It showed a further decline to 0% on a monthly basis, from the previous 0.2% and on expectations of 0.1%. The core CPI, the release that does not include food and energy prices, performed in a similar manner.

Considering that we have a Fed that is “inflation-centric” and that it just changed its mandate in the middle of a pandemic to target average inflation targeting, such resilience makes one wonder what is going on? Will the Fed rely solely on fighting the pandemic now and focus on inflation later?

Also, some investors, like the legendary Stanley Druckenmiller, appeared several times in public, stating that he fears much higher inflation in the United States in the next five to six years. Well, if that is the case, it is certainly not visible yet.

US: CPI Inflation. Source: Oxford Economics

Disinflation Coming in 2021

No one says that higher inflation will come in the years ahead. However, traders and investors must understand the difference between different types of inflation.

For instance, everyone has heard of hyperinflation. This is what happened in Venezuela, Zimbabwe, Argentina and Turkey – the money lost value fast.

Disinflation refers to a decline in the inflation rate. However, it still shows inflationary prices, although the rate moves from a higher to lower inflation. For instance, a move from 6% inflation to 4% inflation is called disinflation.

Finally, when inflation drops below zero, deflation occurs. Out of the three, this is the most difficult one to combat with traditional monetary policy tools. Moreover, as we have seen in the last years, it is difficult to combat also with unconventional monetary policy tools (e.g., quantitative easing).

A study ran by Oxford Economics sees disinflation as the theme in 2021. More precisely, while the headline inflation is expected to rise above the 2.5% level in the first half of the year, it is seen declining toward 1.5% in the second half of 2021.

However, such scenarios are difficult to predict with accuracy. Inflation, as we have seen many times, depends on a lot of factors. Oil prices, for instance, are one such factor—also, the velocity of money and the willingness of the consumer to spend.

All in all, future inflation levels will depend on how the pandemic evolves. For now, higher inflation levels are seen only if and when the world manages to handle the pandemic. Until then, the zero and below levels are more likely.