Single-family homes for housing by KB Home will be shown under construction in the community in Valley Center, California, June 3, 2021.
Mike Blake | Reuters
If the Federal Reserve’s view of inflation is prevalent, a few important things need to go right, especially when it comes to getting people back to work.
Solving the job puzzle has been the most troubling task for policy makers in the pandemic era, with nearly 1
There is a fairly simple inflation dynamic at play: the longer it takes to get people back to work, the more employers will have to pay. These higher wages will in turn trigger higher prices and may lead to the kind of prolonged inflationary supernatural pressures that the Fed is trying to avoid.
“Unfortunately, we see good reasons to believe that work participation may not return to its own quickly
level ahead of Covid, “said Ian Shepherdson, chief economist at Pantheon Macroeconomics, in a note. Whatever happens here, the Fed needs a large number of these people to return to the workforce in the fall. “
The inflation rate is crucial for the economic path. Inflation that runs too high could force the Fed to tighten monetary policy faster than it wants, which could cause cascade effects for a debt-dependent economy and thus critically tied to low interest rates.
Consumer prices rose at a 5% pace year-on-year in May, the fastest since the financial crisis. However, economists generally agreed that much of what drives the rapid rise in inflation is due to temporary factors that will ease as the recovery continues and the economy returns to normal after the unprecedented pandemic shock.
However, it is far from certain.
The Atlanta Fed’s benchmark for “sticky” inflation or prices of commodities that do not tend to fluctuate much over time rose 2.7% year-on-year in May to the strongest growth since April 2009. A separate target for “flexible” CPI or Prices that tend to move frequently rose by a staggering 12.4%, the fastest since December 1980.
In their latest forecast, Fed officials put core inflation at 2.2% throughout 2021; Shepherdson said current figures suggest something closer to 3.5%.
“It’s a huge miss, and it potentially poses a serious threat to the Fed’s benign view of the medium term because of its potential impact on the labor market,” Shepherdson said.
What keeps workers at home
Studies show a number of factors preventing workers from taking jobs: ongoing pandemic issues, childcare problems, especially for women, and improved unemployment benefits, which are being withdrawn in about half of the states and expire in September.
From the employer perspective, concerns about skills disparities have persisted for several years and have worsened during the pandemic. For example, a study by online learning firm Coursera showed that the United States has dropped to 29th in the world in digital skills needed for high-demand entry-level jobs.
The dilemma is a pervasive problem in American business today.
David Wilkinson, president of NCR Retail, the cash register maker that now supplies a range of products and services to the industry, said he sees “a bit of a work crisis” unfolding.
“As labor becomes harder to come by as labor becomes more expensive, the other side of the inflationary concern is that as prices rise, the cost of living rises and people have to be paid more when they demand more,” Wilkinson said. “All my clients are struggling to be staffed at a level that they need staff to really get to the other side of this wave.”
While he believes that inflation will eventually fall from the current level, he expects it to be higher than the below-2% that prevailed for most of that era after the financial crisis.
The implementation of technology accelerated during the Covid era. As it continues, Wilkinson said he also expects to see retailers pay higher wages to fill labor demand.
“We see an increased focus on the employee in the retail trade, and part of that is both the experience, the technology they need to do the job, and part of that is the willingness to pay,” he said. “This brought it back to the forefront.”
Managing its path through the various dynamics may prove difficult for the Fed.
Previous attempts to normalize policy over the years have largely failed, with the central bank having to return to the zero-interest money-printing world that emerged during the financial crisis.
“The Fed is trapped,” wrote Joseph LaVorgna, chief economist of America at Natixis and former chief economist of the National Economic Council.
While LaVorgna sees inflation as remaining relatively under control, he believes the Fed may face problems from deflationary pressures. The Fed does not like inflation that is too low as it creates a cycle of low expectations that limits monetary policy during downturns.
“The political pressure to do nothing will be intense,” as government debt rises, LaVorgna said. “If the Fed cannot (or will not) remove excessive political adjustment when the economy is booming, how can decision-makers do so when growth is always slowing down?”
Markets betting on the Fed
In fact, markets do not expect much movement in politics at all.
Treasury interest rates have actually fallen since Thursday’s report on warmer-than-expected consumer price indices, and market prices now point to no rate hikes until around September 2022 and a Fed rate of just 1% until May 2026.
A report Friday from the University of Michigan also showed that consumers are lowering their inflation expectations, with expectations for the year ahead of 4%, down from 4.6% in the last survey, and by 2.8% over five years, down from 3%, although it is still well above the Fed’s target of 2%.
“Despite all fears that the Fed will be asked to tighten policy early to curb inflation, we anticipate that officials will be just as concerned about a slowdown in recovery in real activity,” wrote Michael Pearce, senior U.S. economist. at Capital Economics.
The Federal Reserve Board Building is pictured in Washington, USA, March 19, 2019.
Leah Millis | Reuters
Fed officials are likely to talk next week about how the risk is tilted in the current scenario. They have been lukewarm about recovery and continue to emphasize the role of the pandemic, albeit declining, and encourage a full political response.
But if inflation readings continue to rise, the pressure to at least press the brakes on monthly asset purchases will build.
“There’s been this debate about whether inflation is different this time around,” said Quincy Krosby, chief market strategist at Prudential Financial. “If inflation rises in a more material and less temporary way, consumers will need higher wages.”
The Fed is betting that a return to the labor market, especially of women, will help keep wage pressures down and keep inflation in check. The current labor force participation rate for women is 56.2%, up from a pandemic low, but otherwise the worst since May 1987.
Despite the inflationary pressures, the Fed last year amended its mission statement to keep policy accommodating until the economy sees inclusive labor gains, meaning across gender, income and race.
“They will make sure that the slide to [policy] liftoff is long, “Krosby said.” The question is, if inflation rises in a more meaningful way and is more sticky, what does the Fed do? That is the concern of the market. “
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