Citi’s chief economist for the United States, Andrew Hollenhorst, highlights in a report distributed to his clients on Tuesday that, since the beginning of this year, his team has maintained that inflation is above the targets set by the Federal Reserve it would probably be more persistent what the market and the officials of the country’s central bank expected.
“This is clearly the case at the moment, as longer-lasting supply chain problems have led to continued rapid increases in goods prices,” says Hollenhorst, adding that his focus is now on the the possibility that wage increases associated with the rigidity of the labor market drive service inflation and are integrated into expectations.
Citi foresees an annual core Price Index on Personal Consumption Expenditure (PCE) of 2.5% by the end of 2022, but warns that the risks could still point to even higher increases.
They also explain how after a decade in which markets have focused on the inability of central banks to generate inflation, the regime is changing to one in which central banks they will have to maintain credibility to be willing and able to avoid scenarios of higher inflationary pressure beyond the established goals.
“We consider that the risk of a price and wage spiral like the one in the 70s in the US is the highest since that same period, “Hollenhorst points out. In this sense, for Citi economists there is also a growing risk of a possible regime change for the Federal Reserve, which could have to tighten its policy to avoid a cycle of rising wages and prices.
This would be a major regime change for financial markets, where Treasury yields rise (and prices fall) at the same time as the prices of risk assets fall, meaning that fixed income no longer serves as a hedge for positions in risky assets.
For Hollenhorst and his team, the debate between the idea of a “transitory” versus a “persistent” inflation has focused largely on the price pressure based on goods and data, which currently they clearly opt for the not so transitory side. In fact, they consider that supply problems will accompany us well into 2022 while the exceptional demand for goods continues.
Another argument that questions the transitory nature of inflation is the wave of workers that some expected to return to the labor market with the reopening of schools and the expiration of unemployment benefits, which has not materialized. At the same time, prices of services have started to rise with wages.
While these dynamics will influence the levels for inflation in 2022, expectations already increasingly reflect higher and more entrenched inflation, which can ultimately lead to higher inflation in the long run.
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