When behavioral finance experts look back on the pandemic economy a decade from now, one question they will certainly wrestle with is why so few people saw inflation coming and why so many experts were so wrong for so long.
How did so many economists and money managers dramatically miss the mark? One likely reason is that they extrapolated the lessons of the last crisis onto this one: The Great Financial Crisis forged a business climate of weak demand and plentiful supply, conditions that endured for more than a decade and fostered ongoing deflation. What the economists likely missed was the reflationary trends: deglobalization and rising nationalism, things that had surfaced several years before the pandemic.
From 2009 to 2019, the CPI averaged 1.77% annually. In the previous two business cycles, it averaged 2.75%, according to Erik Weisman, portfolio manager and chief economist at MFS Investments.
Inflation skeptics may yet be proved right, he continues. Even though bond yields have moved up slightly in 2022, the bond market is sending a message that powerful secular forces like digitalization and demographics could eventually reassert themselves and override supply-chain problems, which could likely resolve themselves, leaving inflation ultimately subdued.
But for now, the characteristics of the current recovery seem to be almost the exact opposite of those in the previous rebound. Some industries have been hit with three years of cost increases compressed into a single year.
The Great Recession was a “balance sheet recession,” Weisman notes, as consumers and companies focused on deleveraging at a time when decimated home equity had constricted their spending. In contrast, the current housing boom is being fueled by a releveraging cycle among households. Like state governments, many U.S. families still have bank accounts flush with stimulus cash. As housing in many areas gets reappraised, state and local governments are running surpluses, another rare event for early-stage recoveries.
Surprise, Surprise
Month after month, various inflation metrics have surprised economists to the upside, not just in America but in Canada, the United Kingdom and numerous other nations. “Why is anybody surprised?” asks Michael Cuggino, president and chief investment officer of the Permanent Portfolio Family of Funds. He contends that the notion of a frictionless reopening of the global economy after more than a year of lockdowns and disruptions was fantasy.
What’s striking about the current bout of inflation is its universality. Whether it’s food or fuel or housing, people are paying more for basic goods—and Americans seem able to do it so far. What they don’t want to pay for are stocks and bonds, Cuggino says (at least not so far this year), since the markets themselves seem to doubt the Federal Reserve’s story that inflation is temporary.
In late 2021, DoubleLine Capital CEO Jeffrey Gundlach pegged inflation at 5% for 2021, and he reminded CNBC in early February of this year that this high estimate made him an outlier at the time. But he conceded that even he missed the mark, as inflation began 2022 running much higher—at 7.5%.