However, even as job growth remains weaker than we would like, a tightening labor market is contributing to a general heating up of inflation. Over the past two years, the average hourly earnings of production and non-supervisory workers have increased by 10.4%, the strongest two-year gain (apart from pandemic distortions last year) since 1983.
Faster-growing wages are clearly contributing to higher inflation overall. However, this is not the only issue as supply bottlenecks are increasing prices for a wide swath of consumer goods.
Rising energy prices have more recently become a problem, with WTI oil prices rising above $80/barrel last week and natural gas prices climbing above $6 per million BTU. The oil price surge reflects a global recovery in demand as pandemic effects fade and some discipline on the part of the OPEC+ group as it only slowly ramps up production in response. The natural gas spike, at least in the U.S., has partly been caused by hurricane disruptions to production although rising demand is also a factor. Finally, rents have started to rise very sharply across the country reflecting soaring home prices and, perhaps, the effect of the end of the eviction moratorium.
Some of these inflationary pressures will show up in Wednesday’s CPI report, which we expect to show a fourth consecutive month of greater than 5% year-over-year gains in consumer prices.
It should be recognized that most of the recent inflation increase is likely transitory as the Federal Reserve has argued. High prices themselves provide a powerful incentive to producers and distributors to get goods to market thus relieving price pressures. However, it is looking increasingly likely that some of this higher inflation will linger. In particular, the effects of fast-rising wages, fast-rising rents and, most of all, higher inflation expectations should keep inflation well above the Fed’s long-run 2% target through 2022 and into 2023.
Policy makers would undoubtedly like to see stronger growth and cooler inflation. However, this is simply not the economy we have and we expect the Federal Reserve to bow to this reality by announcing a plan to taper bond purchases at its meeting next month and to start raising short-term interest rates before the end of next year.
For investors, it is also important to recognize reality. While there are many great American companies that will be able to flourish even in a slower-growing U.S. economy, it makes sense to be globally diversified to benefit from markets that are more attractively priced today and economies that have a better potential for strong growth with low inflation going forward.
David Kelly is chief global strategist at JPMorgan Funds.