Summary: The formation of persistent inflation does not happen overnight. In its different stages, there are often different driving factors, and currency often plays a “pin-and-pin” role in it.
Since the second quarter of 2021, inflation has become the focus of the US macro economy. Whether it is the Fed setting policy interest rates or market participants deciding on asset allocation plans, it is important to clarify whether inflation is temporary or continuous. Generally speaking, the Fed will not change its policy stance because of temporary inflation, and the market will not reprice it.
The economic cycle is an important factor affecting prices. The reason why inflation exceeds expectations in the post-epidemic era is closely related to the deep V-shaped economic recovery. Therefore, judging future price trends from the economic cycle is an optional method.
The unemployment gap is often used to measure the economic cycle. If the price of a certain product or service is negatively correlated with the unemployment gap and is statistically significant, then it is called a cyclical product or service, otherwise it is acyclical of. Based on this, the price index can be divided into a periodic part and a non-periodic part.
In the post-epidemic era, fluctuations in core PCE prices are also mainly caused by non-cyclical parts. From February to April 2021, the year-on-year increase in core PCE prices dropped from 1.91% to 0.91%. Among them, the non-periodical part dropped from 1.2% to -0.44%, and the cyclical part dropped from 3.24% to 2.95%. In the early stage of economic recovery, the rebound in core PCE prices also mainly originated from the non-cyclical part. Its low point appeared in April 2020, while the cyclical part did not bottom out until October 2020. Beginning in March 2021, the price increase in the non-cyclical part has expanded significantly, surpassing the cyclical part in April. At the same time, the growth rate of the cyclical part is also accelerating. The combined force of the two makes the core PCE price increase break through 3% in April 2021, setting a record for this century.
The inflection point of the non-cyclical part has appeared in May. Among them, the increase in health care prices appeared as early as February (3.72%). From February to June (2.68%), it has fallen by more than 1 percentage point, compared with the beginning of 2020. (2%) is still 0.7 percentage points higher. From the perspective of the unemployment gap, the U.S. economy may enter an overheating stage after the third quarter of 2021. Moreover, housing inventories are still at a low level, and housing prices are still at an early stage. Therefore, the price increase in the cyclical part is likely to increase. New highs (or oscillating at highs).
However, because the direction of the core PCE is determined by the non-periodic part. One is because the weight is higher, and the other is because the decline is greater. The author believes that starting from the third quarter of 2021, the direction of the two forces has turned downward, and the price increase of core PCE also tends to decline. The key is, is this decline temporary or continuous? The answer depends on the sustainability of wage increases.
Since the third quarter of 2014, the overall wage increase in the United States has increased significantly, from 2.3% to 3.7% before the epidemic. Since the epidemic, the overall wage increase in the United States has slowed down. As of June 2021, the year-on-year increase has dropped to 3.4%. However, since July, as the unemployment gap has been gradually repaired and may turn negative at the end of the third quarter, wage growth has begun to rebound. Among them, the most obvious increase was in low-wage positions, which has rebounded 0.6% from the low point. Due to the low employment willingness of the labor force, the job vacancy rate is still at a historical high, the shortage of the labor market will continue to be maintained, and the upward wage increase will continue. Therefore, the cyclical part of the core PCE price is still supported, and the downward trend of the core PCE inflation rate will also be more moderate.
On the whole, June to July is likely to be the high point of the US inflation rate. Combined with data from the US macro economy and consumer confidence since the second quarter, it is basically possible to confirm the temporary nature of current inflation. However, the uncertainty caused by mutant viruses or geopolitics may still disrupt the downward path of US prices in the second half of the year, and may even reverse the downward trend. For this reason, it is necessary to further analyze the reasons for this round of price increases, and to understand the long-term impact of the new crown epidemic on supply and demand and consumer behavior.
The formation of persistent inflation does not happen overnight. In its different stages, there are often different driving factors, and currency often plays a “pin-through” role in it. Without loose monetary conditions and continued upward wages, inflation is likely to be temporary.
It is worth emphasizing that according to historical experience, currency is not a sufficient condition for inflation, but a necessary condition. If the increase in the growth rate of the money supply coincides with the decrease in the velocity of money circulation, inflation will be difficult to form. At present, the necessary conditions for monetary easing are already in place, and the momentum for rising wages is also gathering.
