Seven years ago, former Federal Reserve Chairman Ben Bernanke spoke at Schwab Impact’s annual conference in Denver. Asked about the vituperative criticism that his quantitative easing policy following the financial crisis would spark runaway inflation, even the courtly, soft-spoken South Carolinian could barely conceal his contempt for the critics. Back in 2014, it was clear the biggest concern was deflation.

Seven years later this past October, Bernanke returned to the Schwab event in a very different world. That month the Consumer Price Index hit 6.2%, the fifth month in a row the inflation gauge consumers see topped 5%. It was the highest level since 1990, when the lead-up to the first Persian Gulf War caused a spike in the price of oil. One of a few other monthly inflation numbers that was close came in July 2008, when the economy was entering the worst recession in 80 years.

Circumstances today are very different from 1990 and 2008. No one is talking about a recession, but the massive run-up in debt and the jump in prices look eerily similar.

So do certain conditions in the labor market. Over the last six months, the unemployment rate has dropped 1.5% to 4.6%. “If this measure of unemployment is accurate, the expansion is getting old,” Jim Paulsen, chief market strategist at The Leuthold Group, says.

But when the economy emerged from recessions in 1991 and 2009, the balance of power between employers and workers in the labor market was tilted in favor of employers. Today, many businesses like restaurants and trucking companies are turning away business because they can’t find enough workers.

Labor shortages aren’t simply driving up costs; they are constricting growth. A company can’t “maximize their business model if they can’t find people,” says Michael Cuggino, president and chief investment officer at Permanent Portfolio.

Asked about the current bout of inflation, Bernanke told advisors that a lot of the price problems are associated with reopening the economy after a pandemic-driven lockdown. However, Bernanke said if inflation were running above a 2.8% or 3.0% rate a year from now, the Fed’s credibility would be at stake. It would be apparent the central bank misread the ramifications of its monetary policy in 2020 and it could be forced to act aggressively.

Some observers think Bernanke was being generous to his former colleagues. “The Fed already has a credibility challenge,” Erik Weisman, chief economist and portfolio manager at MFS Investments, says. “They are asking for a time-out.”

Fed chairman Jerome Powell has indicated the central bank doesn’t want to make “a determination until the second quarter” of 2022, Weisman continues. In the face of mounting evidence they misread the economy, the Fed’s position is “to stick to their strategy and hope.”

What’s striking is how expectations among professional investors and the public alike have changed to the point that some experts think that a 3.0% inflation rate in 2022’s fourth quarter would confirm that it’s not a long-term threat. In contrast to past inflation surges that were confined to a few sectors like energy, the current round has pervaded almost every sector of the economy in a fashion reminiscent of the 1970s.

Still, some like J.P. Morgan Asset Management’s chief market strategist David Kelly don’t think the Fed is so far off. He told clients recently that price hikes in energy, food and automobiles are likely to level off as bottlenecks subside in the next year and said the CPI should be running at about 2.3%.

But if the 2.8% to 3.0% inflation benchmark that Bernanke tossed out at the Schwab event is the new normal, it marks a serious departure from the past decade. “That would be an approximate 50% increase from the Fed’s stated long-term goal of 2%,” Cuggino says. “Given recent and increasing inflationary pressures, there may be an upward bias to go well beyond 3% on a longer-term basis.”

It also could turn out that the 2% inflation level consumers and businesses have grown accustomed to since the 2007-2009 financial crisis may be the actual aberration. Weisman notes that for the 15 years starting around 1990 a 3% rate was the norm—and that was considered modest after the 1970s and 1980s.

No V-Shaped Boom Yet
It’s increasingly clear that the sharp, V-shaped recovery that much of Wall Street and the Fed were anticipating last spring is materializing. When the vaccination rollout spawned a dizzying euphoria in April, some economists predicted America would enjoy a year of 10% GDP growth not seen since the 1950s. “You can’t voluntarily shut down the global economy and then snap your fingers and expect everything to come back,” Cuggino says.

Labor markets are likely to dictate the ultimate trajectory of the economy and financial markets in the next few years. Bernanke told advisors at Schwab that this was the strangest labor market he had ever seen.

Indeed, with more than 10 million job openings, it seems incongruous that more than 4 million people have been quitting their employers every month since April. Contrary to popular stereotypes, these folks are not all waiters and waitresses looking to move up the income ladder, nor are they the wealthy boomers and clients of financial advisors retiring a year earlier than they had planned. As The Leuthold Group’s Paulsen told clients in a note, “The U.S. labor force was never hit as hard as it was in 2020.”

Over the last six months, the unemployment rate has dropped 1.5% to 4.6%. “If this measure of unemployment is accurate, the expansion is getting old,” Paulsen continues.

Like many, he surmises the bizarre circumstances created by the pandemic probably have “temporarily” shrunk the labor force. Some job market exiles are dealing with new child-rearing problems. Others are afraid to return to work for health concerns, and still more are likely to be engaged in a midlife career rethink.

Retirements are estimated to be running somewhere between 50% and 75% ahead of where they were expected to be before the pandemic began. “We’re seeing 1 million to 1.5 million more retirements” this year, Weisman says.

If the experience after the financial crisis is any indicator, a sizable chunk of those retirees may return to the workforce, on a part-time or full-time basis. But a lot of people with fat 401(k) balances are feeling flush. Weisman points out that a “job as a greeter at Office Depot may not be as enticing” to older workers when their wealth “has gone through the roof.”

He believes the Fed is likely to be very slow to realize there “has been a structural shift in labor markets.” It shouldn’t be. A decade ago, demographers were warning that there would be labor shortages in the 2020s as baby boomers retired.

“Today’s employment level is still 4.7 million below the record high” achieved before Covid arrived, Paulsen writes. “Every economic expansion of the postwar era was associated with new record labor force numbers.”

There is a silver lining in all the chaos. For several years, most advisors looking to grow their firms say the biggest constraint is a talent shortage.

“For a young person looking to start a career, it’s a great opportunity,” Cuggino says. “You can be choosy about jobs.”

What’s good for young workers may not be good for financial markets. “The markets believe the Fed can raise rates and take the steam out of inflation without causing a recession,” Weisman says. “It seems a little too good to be true.”