The Federal Reserve of the United States (Fed) and the U.S. Treasury are not concerned with higher inflation. Both institutions expressed their confidence that they will know how to deal with higher inflation, should it come. Through the voices of their leaders, Jerome Powell, respectively Janet Yellen, the two institutions expect higher inflation but do not fear it.
After all, the fear was greater when inflation threatened to break below zero than now when it is barely close to 2% (the original Fed’s target). Yet, their wish may come true quicker than expected.
This week, on Wednesday, the U.S. CPI (Consumer Price Index) was the top economic data on the trader’s agenda. It shows a moderate increase in headline inflation and even a decrease in core inflation (i.e., that excludes energy prices as they are too volatile). Where is the inflation, one might ask?
NFIB Leads U.S. Core CPI By Six Months
Those claiming higher inflation is imminent have two main arguments. One is that the aggressiveness of the monetary and fiscal stimulus would inevitably lead to a lower dollar, hence, higher inflation. Another is that the advances in the price of oil will further fuel the move lower in the dollar. Both arguments are sound but not necessarily compelling.
Not everything in the monetary and fiscal stimulus is inflationary. To exemplify, think of quantitative easing or asset purchasing – it is mainly an exchange of swaps. No inflation comes out of it, and the evidence lies in the last decade of quantitative easing around the world with no increase in inflation.
Furthermore, higher oil prices lead to inflation, but that is viewed as temporary. Therefore, is the fear of inflation granted, considering the counter-arguments from above and the recent inflation data? The right answer is that yes, the fear is granted; only the timing lags.
NFIB is an association of small businesses in the United States, and it runs a survey showing both the optimism in the sector as well as price changes over a period. It releases a leading inflation indicator by about six months compared to the actual core inflation. In other words, right by the end of the summer of 2021, the Fed and the Treasury should face higher inflation.
The Fed changed its mandate last year to accommodate higher inflation via its new Average Inflation Targeting (AIT) framework. If the NFIB leading proves accurate, the first test of the AIT framework will come sooner than the Fed is expecting – with ripple effects on financial markets.