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Inflation: How transitory?

October 13, 2021

S&P GSCI Commodity Index Chart

What’s causing inflation to rise?

Global inflation has been running at elevated levels for much of 2021, with the core PCE deflator (the inflation metric preferred by Federal Reserve bankers) reaching 3.6% in August. That’s nearly double the Fed’s 2.0% target rate and the highest level for this inflation indicator since 1991.

Since the global financial crisis, the Fed has actually been more worried about deflation than inflation. Only 8% of monthly inflation readings were above the Fed’s 2% target. The more recent inflationary pressure has been largely due to supply chain disruptions and labor shortages, but increasingly commodity prices are contributing to the rise in prices. We see this in the S&P Goldman Sachs Commodity Index, which is now up 42% for the year and 10% over the past month. (See above chart.) Also, lumber prices more than tripled between October of 2020 and May of this year but have since declined. Agricultural prices have been elevated too, due to global demand and drought conditions.

Recently, markets have paid significant attention to energy prices, with crude oil touching $80 per barrel for the first time since 1994. Natural gas prices have exploded higher due to electricity demand in Europe, with domestic prices there nearing $6/MMBtu and panic buying driving local prices to over $50/MMBtu. Similar spikes have been seen in coal; with China struggling to meet electricity needs, coal prices touched $270/MT this week, nearly five times the pre-pandemic level.

Elevated energy prices are another brick in the current “wall of worry” for investors, representing a substantial headwind for the global economy. This is particularly troubling for the 44% of U.S. households defined as low income, who spend an average of 10% of their household income on energy needs, nearly four times that of moderate-to-high earning families. The rise in energy prices also comes against a backdrop of COVID-related income losses; low-wage earners are currently making 26% less than they did pre-pandemic, while middle-wage earners are making 3% more and high-wage earnings making 10% more.

These factors are among the reasons why “stagflation” is appearing more frequently in news articles and why he Atlanta Fed’s GDPNow model forecasts just 1.0% GDP growth in the 3rd Quarter. Investors continue to believe Fed Chair Powell’s contention that inflationary pressures are transitory, but the definition of “transitory” seems to be changing in real-time.

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