When the coronavirus pandemic began, economists were worried about deflation, but the producer price index and the consumer price index each rose 0.6% in July, while the Federal Reserve Bank of New York’s Survey of Consumer Expectations showed a rise in expectations at both the one- and three-year horizons, suggesting otherwise.
The Federal Reserve stands by its expectations. The latest Federal Open Market Committee meeting minutes state: “that the negative effect of the pandemic on aggregate demand was more than offsetting upward pressures on some prices stemming from supply constraints or from higher demand for certain products, so that the overall effect of the pandemic on prices was seen as disinflationary.”
And, the minutes note, personal consumption expenditure prices on an annualized basis “would likely continue to run well below the Committee’s 2% objective for some time.”
Comments from Fed Chair Jerome Powell and other FOMC members suggest “they expect the U.S. economy’s recovery from the COVID-19 pandemic to be very slow and uneven,” said Peter Ireland, an economics professor at Boston College and member of the Shadow Open Market Committee.
“They clearly believe that the supply disruptions caused by the shutdowns and associated health precautions are being reinforced by considerable weakness in aggregate demand, reflecting greatly diminished consumer and business confidence,” he added, noting this meshes with the most recent Summary of Economic Projections, which has inflation “running well below the 2% target through 2022.”
The panel’s view as “very pessimistic,” Ireland said, since recent data, especially employment and consumer spending, “point to a quicker and more robust rebound.”
Plus, the latest reports also suggest “a more rapid recovery or re-normalization,” with prices of items that had fallen rebounding and prices of items that surged (notably groceries), returning to lower levels.
“Overall, in light of these data, I’m much more optimistic that the FOMC, both about the outlook for real growth and employment and the outlook for inflation,” Ireland said. “My best guess is that by next spring — say the second quarter of 2021 — the outlook for the U.S. economy in general and inflation in particular will look pretty similar to what it was at the start of 2020.”
And while “it’s far too soon to worry about” inflation rising above 2%, he added, “the threat of a persistent bout of very low inflation has diminished considerably, based on the last few months of data, and that’s really great news.”
Scott Colbert, executive vice president and chief economist at Commerce Trust Co., has “been saying for quite some time that inflation was likely to continue trending down,” because of demographics, technology, relatively restrictive monetary policy and aggregate demand.
In terms of demographics, the aging continues and recessions cut into the birth rate “accelerating our aging trend ever faster,” he said. “Technology only continues to accelerate and become a larger and larger part of the economy and the pandemic only further accelerated its importance as those mega cap technology companies continue to grow and expand while companies look to downsize their physical footprint.”
Stimulus has increased aggregated debt “to GDP ratio closer to 1.25 times,” Colbert noted. “The only thing that has changed has been monetary policy over the past 12 years,” he added, with monetary policy “very accommodative during the last Great Recession, driving interest rates down to nearly zero for the seven years ending in 2015 and implementing QE for the first time in modern history. And we are right back at it today.”
The Fed acted quicker than in the past “and will likely provide an even larger ultimate package of quantitative easing while ‘helicopter money’ has been spread via deficit spending with nearly $3 trillion in direct transfer payments to individuals, businesses, health care providers and state and local governments,” he added. “This has helped keep the initial shock of deflation at bay.”
Although April CPI was the lowest ever (-0.8%), July showed a strong rebound: 0.6% (the largest monthly gain since 1991). “Rapidly accommodative monetary and simulative fiscal policy combined to nip deflationary forces in the bud this go around,” Colbert said. “Even though this recession is likely to be more than twice as deep as the previous recession, the low tick on year-over-year CPI inflation remained a barely positive 0.1% and currently stands at a surprisingly robust 1%.”
Commerce doesn’t “expect a huge break out in longer term inflation. But at the same time, an ever-aggressive Fed and an amazing amount of fiscal deficit spending have helped boost the near-term inflationary outlook and have largely eliminated that ‘left tail risk’ of deflation we witnessed during our great recession.”
Rates should remain accommodative “for the foreseeable future,” he added. “The Fed wanted to eliminate the potential for deflation: Mission accomplished. But since the Fed undershot their inflation target during the last recovery, they seem willing to overshoot their target in this recovery, at least temporarily. While that quite possibly is likely to occur, don’t lose sight of the secular forces that have been at work and remain in place keeping a lid on the longer term inflation outlook.”
Inflation should remain “modest” through next year, according to Stephen Gallagher, Societe Generale chief U.S. economist and head of research in the Americas. He agreed that prices that fell during the pandemic, notable airfares and hotels that “plunged” under stay at home orders will rebound, generating “high short-term volatility in the price measures.”
The rise in the indexes in the latest read can be attributed to “a reversal of steep price declines that occurred during lockdown,” Gallagher added, and “are unlikely to persist for long.” But aside from prices recovering as restrictions are lifted, he said, “there is little pricing power to sustain price increases. High unemployment and tremendous uncertainty on demand for a wide range of consumer goods should restrain prices well into 2021 and beyond. The Fed is more concerned with further dis-inflation and are propping up inflation expectations via policy moves. We believe the Fed is taking the correct approach. We see the Fed struggling to reach inflation goals, but should eventually be successful.”
But, getting to the Fed’s 2.0% target “may take several years,” he said. “We do not expect inflation to rise to 2.0% this year. Inflation can touch the goal post in spring of 2021 but that result is the easier comparison to March-April of 2020 rather than strong and sustainable pricing power.”
Separately, existing home sales surged 24.7% in July to a 5.86 million seasonally adjusted annual rate after a downwardly revised 4.70 million rate in June, originally reported as 4.72 million, the national Association of Realtors reported Friday.
Economists polled by IFR Markets expected a 5.39 million unit pace.
July’s percentage gain was the highest on record, topping June’s 20.7% gain.
All regions posted double-digit gains from June, and all regions except the Northeast rose from last July.