Expect inflation till Fed gets tough
Two narratives about inflation forecasts for this year are currently competing.
The first — and, for a while, the most dominant — is that inflation is largely Covidinduced and that as we get a handle on the virus, supply chains will heal and rising prices will subside.
Who could blame economists and policymakers for thinking this way? Inflation hasn’t been a serious problem in the U.S. since the 1980s.
The second narrative, which becomes more apparent by the day, is that inflation pressure will persist the rest of this year and beyond.
Energy prices — particularly for transportation fuels such as gasoline and diesel — have not yet fully worked their way into the Consumer Price Index numbers. No doubt we have seen many immediate effects, but other developments will lag and only show up in the official inflation numbers months later, with gasoline and diesel prices merely among the most obvious.
Another driver of inflation will be China’s continuing impact on the global supply chain. Shanghai is currently on COVID lockdown, which is China’s preferred method to stem outbreaks. If the lockdowns fail to stem the spread
of COVID, the export hubs of Shenzhen, Guangzhou and Hong Kong along the Pearl River Delta are at risk of shutdowns or slowdowns as well. This will exacerbate global supply chain woes even more.
Perhaps the most concerning aspect propelling inflation centers on the Russian-ukrainian conflict. Planting season for wheat in the Northern Hemisphere is underway, but planting will happen only if circumstances allow. Because of the war, Ukraine’s harvest for export will shrink or disappear for 2022, perhaps longer, due to the widespread
inability to sow. For different reasons, Russia’s wheat exports will decrease significantly also.
The other concerning issue deals with the interruption of fertilizer exports from Russia, Ukraine and Belarus. Fertilizer shortages emanating from supply chain interruptions will also take time to work their way through the system, causing prices for food to rise even further. While the U.S. is a significant exporter of wheat, global shortages will mean higher prices for consumers everywhere.
In addition, the Biden administration announced it will
allow the use of higher ethanol blends over the summer by providing waivers to refiners. Though this is expected to reduce the price of gasoline at the pump about 10 cents per gallon, it will also drive up the price of corn.
Some relief from high gasoline prices has come in the form of a million barrels a day of crude oil released from the Strategic Petroleum Reserve. This will help but tapping the reserve is not a long-term solution.
Meanwhile, despite recent harder line jawboning by Chair Jerome Powell, the Federal
Reserve has taken only a tepid approach to raising interest rates as a means to quell inflation. It’s not hard to see why. Rapidly raising interest rates in half-point increments could slow the economy enough to cause another recession — something the Fed fears almost as much as inflation.
Given recent global developments across supply chains — whether the result of COVID variants or the Russian-ukrainian war — it’s hard to paint a rosy picture for the rest of 2022. Even if nothing unexpected happens, hurricane season is rapidly approaching and has the potential to make matters worse.
While the ongoing effort to repatriate supply chains will add stability to U.S. markets, it will take time to implement and will add to inflationary pressures. Consumers should prepare for additional upward price shocks in the coming months by doing things like substituting more expensive items for less costly ones.
Although longer-term consumer inflation expectations remain muted, that situation could change, particularly if the Federal Reserve refuses to take a tougher stance to combat the threat. It seems the writing is on the wall — if the Board of Governors of the Federal Reserve chooses to read it.