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Prepared to go "full Volcker?"

Economy and Policy

        March 11, 2022

                Chief Economist Scott Brown discusses current economic conditions.

The CPI rose 0.8% in February, bringing the year-over-year gain to 7.9%. Price increases further broadened across categories. In the early 1980s, the Fed, led by Paul Volcker, raised short-term interest rates sharply, putting the economy into recession, to squeeze inflation. This week, the Federal Open Market Committee is expected to begin tightening, but policymakers appear to be in no great haste to slam on the brakes. In his recent congressional testimony, Chair Powell indicated that the central bank was prepared to do whatever it takes, without reservation, to protect price stability.

Prices of food (+7.9% y/y) and gasoline (+38.0% y/y) are most noticeable to consumers on a daily basis. Food prices have risen largely on labor issues, which may not clear up anytime soon. Energy prices were already up sharply before Russia invaded Ukraine. The Fed doesn’t worry much about supply shocks, which come and go, but the impact of higher oil prices depends on how high and for how long. We’ve had a number of moderate oil price shocks over the last few decades, and they tend to result in weaker growth rather than a higher trend in underlying inflation. Of course, this time is different. The U.S. is less dependent on oil prices than in past decades, but we’re in an inflationary environment to begin with.

The Bureau of Labor Statistics reported that the core CPI rose 6.4% over the last 12 months, “with virtually all of its major component indexes rising over the span..” The price index for consumer durable goods (13.1% of the CPI) rose 18.7% y/y. The price index for non-energy services (57.4% of the CPI) rose 4.4% (up from +1.3% y/y a year ago) and is trending higher. So even if we get some relief in prices of durable goods, higher inflation in services will likely remain a problem.

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The Atlanta Fed’s Flexible CPI (which is made up of CPI components that have frequent price changes) rose 18.2% y/y. The Sticky CPI (which covers items that have infrequent price changes) rose 4.5% (vs. +1.7% y/y a year ago).

“Stagflation” is a combination of stagnation and inflation. We know what inflation is, but “stagnation” can mean different things. Economic textbooks might define it as no economic growth, negative growth, high unemployment, or rising unemployment. With the unemployment rate at 3.8% (trending lower) and growth expected to be moderately strong, we aren’t in stagflation. Could higher inflation and tighter monetary policy reduce economic activity in the months ahead? Possibly, but not likely within the next several months.

Jimmy Carter nominated Paul Volcker to be Fed Chair in the summer of 1979 (Reagan renominated him in 1983). Inflation was 11.8% that summer and peaked at 14.8% in March 1980. The federal funds target rate was 10.5% when Volcker took the helm, and, in a serious of sharp swings (as the Fed attempted to peg money supply growth), peaked at 19% in early 1981, leading to a double-dip recession. The unemployment rate rose to 10.8% by the end of 1982 and real GDP fell 1.1% from 1Q81 to 3Q83 (stagflation). No one should be expecting anything similar, but there is a risk that inflation will continue to rise and that the Fed will have to have to be more aggressive in raising rates.

Recent Economic Data

The CPI rose 0.8% in February (+7.9% y/y, vs. +1.7% y/y a year ago), up 0.5% (+6.4% y/y) ex-food & energy. Higher inflation has been more pronounced in durable goods, but inflation in services is picking up.

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In a sign that inflation is broadening, the Cleveland Fed’s Trimmed-Mean CPI (which excludes the highest 8% and the lowest 8% of the monthly changes in CPI components) rose 0.5% in February (up 5.7% y/y).

The U.S. trade deficit rose to a record $89.7 billion in January, with merchandise imports up 20.0% y/y. Jobless claims rose by 11,000, to 227,000, in the week ending March 5 – still a very low trend.

The Job Opening and Labor Turnover Survey (JOLTS) data showed job openings little changed at 11.3 million in January. Quits were 4.3 million, totaling 48.8 million over the last 12 months.

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The Chicago Fed Advance Retail Sales (CARTS) data showed sales down 1.5% in the fourth week of February, but up 1.6% for the month as a whole (relative to January).

The UM consumer sentiment index fell to 59.7 in mid-February (the survey ran from February 23 to March 9), from 62.6 in February and 70.6 at the end of 2021. Year-ahead inflation expectations rose to their highest level since 1981. Personal finances were expected to worsen in the year ahead by the largest proportion since the surveys started (in the mid-1940s).

The opinions offered by Dr. Brown are provided as of the date above and subject to change. For more information about this report – to discuss how this outlook may affect your personal situation and/or to learn how this insight may be incorporated into your investment strategy – please contact your financial advisor or use the convenient Office Locator to find our office(s) nearest you today.

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