Inflation Is Everywhere—Where’s The Fed?

Inflation is everywhere, from the factory floor to the warehouse gate, the supermarket register, and the kitchen table, as evidenced by a string of inflation reports confirming the rise of commodity prices across the board.

On Tuesday morning, the U.S. Bureau of Labor Statistics (BLS) reported that the Producer Price Index (PPI) — a measure of inflation at the wholesale level — rose at an annual rate of 9.7% in January. The December number stood at a 13-year high.

The PPI number comes a few days after the BLS reported that the Consumer Price Index (CPI), a measure of inflation at the retail level, rose at an annual rate of 7.5% in January, up from 7% in the previous month. It was the highest inflation number since 1982 and ahead of market forecasts.

“We’re currently in this hypersensitive consumer environment where a large portion of the population has been going through a prolonged period of financial challenge, with 55% of U.S. consumers being financially constrained, according to NielsenIQ’s recent Consumer Outlook report,” said Carman Allison, vice president at NielsenIQ. “Additionally, in January 2022, consumers paid +9.7 percentage points more for CPG products, and we don’t foresee inflation settling any time soon. A diverse range of shoppers are looking to trim their grocery budgets amid inflationary pressures without compromising quality and given these financial sensitivities, consumers are putting careful consideration into the products going into their shopping carts in terms of price, quality and safety assurances, health and wellness claims and convenience capabilities through online delivery or in-store pickup.”

The substantial inflation numbers followed a U.S. government report early in the month showing that U.S. businesses added 467,000 jobs in January, well above the 150,000 markets had expected. In addition, unemployment increased to 4%, while the December jobs report was revised upward to 510,000.

When taken together, these reports confirm that the U.S. economy is very close to one of the Fed’s mandates, maximum employment. But it is far away from the other Fed mandate, price stability, usually defined as 2% inflation.

Conventional economics has a standard explanation for this situation. The U.S. economy is overheating thanks to unprecedented monetary and fiscal stimulus during the COVID-19 recession and robust equity and real estate markets that feed into consumer spending.

Economics has a standard solution for this problem: take liquidity out of the economy through interest-rate hikes.

Back in the old days, the Federal Reserve would have acted swiftly, raising the federal funds rate by a full basis point, following such strong numbers on both the inflation front and the employment front. But not these days, when the nation’s central bank seems to have multiple mandates, with inflation being at the bottom of the list.

Meanwhile, the Federal Reserve seems to be hiding behind the theory that inflation is transitory due to supply chain bottlenecks and labor market frictions. The Fed has yet to raise short-term interest rates and it continues to add liquidity with its emergency-era quantitative easing program.

But debt markets cannot wait for the Fed to get its act together and are beginning to do their job. They have been pushing long-term interest rates higher, as investors demand an inflation premium to lend their money out for more than a year. The 10-year U.S. Treasury bond, a benchmark for long-term rates, has crossed the threshold of 2%.

That isn’t a good development for equity markets, especially for profitless companies that trade on the NASDAQ. Thus the sell-off in recent weeks, with the NASDAQ accounting for most of these losses.