U.S. Inflation Update

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The writer of this article is the head of the investment research department of Bridgewater Associates

The US economy today is as strong as it has been for generations, the labor market is the tightest, and the inflation rate has reached its highest level in decades.This may even explain the recent slowdown in growth driven by the spread of the Delta variant of Covid-19, as reflected in Friday’s Disappointing August employment data.

However, the continued digestion of inflation in financial markets will prove to be short-lived, and policymakers will hardly need to respond. We believe that this combination of potential outcomes is unlikely.

Let us first consider Inflation outlook ——Persistent or short-lived? We certainly don’t expect the record consumer price prints earlier this year to continue.

But the positive fiscal stimulus (including another 2-3 trillion US dollars of expenditure that may be passed before the end of the year) is adapted by printing money Stimulate demand There is no corresponding supply.

Households have ample cash, high levels of wealth, and low borrowing costs. When the supply is very limited and it is unlikely to get a substantial improvement soon, they are spending, including for housing.

That Broad and strong consumer background It also leads to the need for companies to recruit-job vacancies exceed the number of job seekers and push up wages in a way that we also believe can be sustained and promote a self-reinforcing economic recovery.

This is not surprising, Deflationary trend We have seen an increase in expectations of currency tightening in recent quarters. We will raise interest rates by 0.25 percentage points twice in the next two years and expect to reduce asset purchases by the beginning of 2023.

But compared to any previous cycle, the expected tightening shift is mild, and it is still very easy compared to the strength of the US economy. At the same time, the inflation break-even curve is drawing a path to return to normal in just a few years, with both nominal and real interest rates approaching long-term lows.

Eventually, the Fed will respond to economic conditions, which brings us to the second part of this future market vision. Does the Federal Open Market Committee, which makes policy, “have almost no concessions”?

There is no doubt that during the pandemic, central bankers face extraordinary challenges in interpreting economic tea. In the growing debate about how to explain the labor market and inflation, the Fed’s difficulty is obvious.

For example, the July FOMC meeting minutes emphasized that employment is still well below pre-pandemic levels, reflecting rising unemployment and people withdrawing from the labor market. However, at the same time, it pointed out that the company is reportedly working hard to hire workers in order to increase wages or provide additional incentives to attract or retain workers.

In the face of labor and inflation, the Fed’s efforts to address supply shortages reflect the extent to which pandemic-related disruptions can be easily resolved, and where the situation will settle once the effects of the pandemic have subsided.

In recent weeks, several Fed officials have stated that they may need to be faster than currently thought, and may begin the tightening cycle at a faster rate. At present, this is a minority view.

More dovish members, including most of today’s FOMC voters and Chairman Jay Powell, are more willing to wait for the distortions associated with the pandemic to subside before judging whether inflationary pressures persist and whether the labor market is in line with the Fed’s goal of eliminating “shortages”

These dialogues are taking place in the context of the experience and lessons of the past few decades. Keeping monetary policy too tight to relax sufficiently is seen as a greater risk than allowing inflation to rise and the need to tighten and catch up later. With the Fed’s new commitment to allow inflation to exceed 2%, a more dovish view is emerging.

Given that the Fed’s goal is to prevent low inflation or deflation from becoming entrenched, as in Japan and to a certain extent in Europe, we sympathize and agree to switch to more accommodative policies. We also do not envy how the Fed must balance the difficult trade-off between growth and inflation risks.

The Fed’s deliberations (and the composition of actual voters and Chairman Powell’s preferences) currently point to a slowdown in tightening policy. We expect the Fed will eventually have to “concession” on interest rates.

More directly, however, we believe that market pricing, data trends, and the Federal Reserve’s changing response function highlight the real need for investors to protect their portfolios from higher and more sustained inflation.