It looks as though markets, both in stocks and bonds, are being traded by people who truly believe that this bout of inflation will prove transitory, and that there is a danger of deflationary ennui once it’s over. Time alone will tell if they are right; for now, the conundrum remains unsolved.
The Two-Year Itch
A number of readers suggest that the fairest way to deal with the transitory effects of inflation is to look at the annualized rate over the last two years. That makes sense but still doesn’t resolve the issue, in my opinion. This chart is by Bilal Hafeez of Macro Hive:
On this basis, headline and core inflation are at 3% and 2.9% respectively. This is nothing terrifying, but is at the top of the Fed’s level of tolerance. If a broader economic reflation lies in our future, these numbers are consistent with a problem at some point. But they certainly don’t prove that any such thing will happen.
Meanwhile, the chart also illustrates that the pandemic is still having possibly deflationary effects. Services inflation is slightly down compared to the two years from 2017 to 2019. Recreation inflation is falling, and must be likely to increase if people really start spending. Shelter inflation over the last two years has run at 2.5%; that is where the attention will increasingly focus over the next few months.
In short, this exercise plainly removes the shock value of the big headline increases. It still leaves us with an inflation picture that doesn’t fit with falling bond yields and a flattening yield curve.
Commodities
What should be made of the rise in commodity prices, and its deceleration in recent weeks? There is a great optimism that the retreat for some commodities, notably lumber futures, shows that inflationary pressure is reducing. There is also the possibility that higher commodity prices will themselves be deflationary, as money spent on basic necessities displaces other spending.
That’s a reasonable hope, but the following chart, in which Deutsche Bank AG’s Jim Reid charted the performance of the Thomson Reuters CRB CoreCommodities index over every economic recovery going back to 1914, suggests that it is premature to sound the all-clear. Commodities are further ahead on this basis than at 12 months into any previous recovery, and have overtaken their 1933 rebound amid the Great Depression. That 1933 rally carried on for another couple of years. This rally is considerably greater than any other at this stage in an economic recovery:
As with so many things in the post-pandemic world, it’s hard to know which precedents to use, and whether any are valid. This was an abnormally sharp shutdown, followed by an abnormally sharp bounce back. It’s reasonable to think that the effect on the commodity market could be similar. That said, the Covid shutdown came as most commodities had endured almost a decade in a bear market. It’s just as easy to hypothesize that Covid provided the cathartic selloff that creates an investable bottom, and then an enduring recovery. It will take a while for us to find out, but it’s premature to take the commodity market as an argument to believe the inflation threat is merely transitory.