Upside-Downton Inflation

By Michael Every of Rabobank

The US CPI report for August is clearly going to be the major market focus today. Expectations are 0.4% m/m headline and 0.3% core, equivalent to 5.3% y/y and 4.2% respectively. Who, especially among those saying inflation is not a problem, had a 5%+ headline figure pencilled in for this stage in the year?

As a warm-up for that report, replete with all the methodological problems covered here before, consider that the New York Fed’s own inflation survey released yesterday showed median 1-year-ahead inflation expectations increased by 0.3ppts to 5.2%, the tenth consecutive monthly increase and a new series high, and median inflation expectations at the 3-year horizon also increased by 0.3ppts to a new series high of 4.0%. Both increases were broad based across age and income groups. In other words, the public the New York Fed, the home of Wall Street, speaks to, still expects inflation twice the Fed’s target in late 2024.

Of course, median inflation uncertainty—or the uncertainty expressed regarding future inflation outcomes—is also at new series highs. After all, if inflation is going to surprise in any direction relative to that 4% figure over the medium term, it is likely to be the downside via a biting deflation. That’s a sugar-high boom/bust picture painted back at the start of this year when I discussed frankly laughable “The Roaring 20s” meme, if sold as by ahistorical teenage scribblers as a positive, while pointing out “If so, can you count to 30s?” And let’s agree the political backdrop is still bang in line with that prediction, with even greater polarisation everywhere, and even greater perceived failings on the part of liberal capitalism: any number of “-isms” are confidently building their own alternative socio-economic prospectuses, just as they did 100 years ago. Socialism; communism; Islamism (via the Taliban’s ‘renaissance’); and, as some argue, neo-feudalism – which I will return to in a moment.

But first back to the New York Fed report. Median year-ahead home price change expectations decreased slightly to 5.9% in August from 6.0%, marking the third consecutive monthly decline: so has US house-price inflation peaked? The thought may please the Fed, who are more into pumping stocks –the survey’s mean perceived probability that US stocks will be higher 12 months from now remained unchanged at 39%, showing they have some work to do there– but it will terrify others. Imagine the RBA: do they think Aussie house prices can rise another 30% this decade, as a hypothetical example? But what will Aussie society look like if so, assuming wages come nowhere near matching that increase? And yet what will the economy look like if house prices don’t rise? After all, that ‘wealth’ (read ‘debt’) effect has been the main fuel in the tank of far too many economies for far too long, as I have gnashed my teeth, pulled my hair, and wailed from Moab about for years. But what do we have to replace it? “I can’t believe it’s not ‘Build Back Better’”.

And while house-price inflation may perhaps have peaked, the survey says this isn’t true for expectations of year-ahead rents, which were up 0.2ppts to a staggering 10.0%; or medical care, up 0.2ppts to 9.7%; or gasoline, up 1.1ppts to 9.2%; or food, up 0.8ppts to 7.9%; or education (college) was up 0.5ppts to 7.0%. Of course, the hypothetical CPI ex-rent, medicine, gasoline, food, and education is still looking benign.

Meanwhile, median 1-year-ahead expected earnings growth fell 0.4ppts to 2.5%, comparable to its February 2020 level, with the decrease was driven mostly by respondents over the age of 40. Mean unemployment expectations –the probability the US unemployment rate will be higher one year from now– increased by 3.3ppts to 35%. The perceived probability of finding a job if one’s current job was lost fell to 54.9% from 57.0%, driven by respondents aged 60 and over. The perceived probability of losing one’s job in the next 12 months increased slightly to 12.4% from 12.2%, but fortunately remains near the series low. Yet the probability of leaving one’s job voluntarily in the next 12 months also increased to 20.0% from 19.7%.

There is lots more one could dive into in this survey, but now back to my earlier point on neo-feudalism. I very belatedly finished watching ‘Downton Abbey’ last night. Only covering the 20s up to 1926, we see a British society suffering depression, the causes of which rightly do not get much dramatic exposition: “Mrs Patmore, I am sure you will agree the return to the gold standard is a necessary evil to ensure sound money?” “Sorry, Mr. Carson, I am too busy working 14-hours a day cooking for the lord and ladies upstairs to notice the anchor for our fiscal and monetary policy.”

What you also see, besides romantic ups and downs, is a society seeing a massive structural shift. The rich are suffering, with great houses being sold off or relying on American dowries to support them, and servants are leaving for better-paid, less-deferential work. The series concludes with even the aristocrats cheering for social and economic progress, and a fairer, more globalized, more modern world. Even Mrs Patmore becomes petit-bourgeoisie with her own B&B, as does staunchly pro-establishment conservative Mr Carson. Some aristocrats actually start to get jobs.

Today, extreme concentrations of wealth and monopoly/oligopoly are being built up rather than dismantled, alongside a new homoploutia (both income and asset rich): and they don’t need the noblesse oblige of full-time servants now swathes of the working class are in the gig economy at everyone’s beck-and-call. A few last, lucky Mrs Patmore’s may squeak in to the buy-to-let property ladder in some places, but the majority of the young face a life of gigging and renting, leaving no assets to their kids; or perhaps having no kids, leaving no society. Meanwhile, social progress is happening at bewildering speed in some places, as massive regression is being seen in others – and often in the same country at the same time.

Of course, as in Downton, all things are fluid. China is acting for ‘common prosperity’; the Biden administration is floating (if not delivering) massive structural increases in social spending; and in the US, Amazon is offering free degrees to some of its employees, a radical extension of Marx’s prediction of the proletariat learning how to rule from capitalists. Moreover, the Financial Times quotes Scott Price, president of UPS International, stating that in response to the inflation –and shortages!–we are seeing, multinational retailers and manufacturers are now regionalizing their supply chains: “A lot of companies are coming to us saying ‘where is the best place to put manufacturing and assembly?’ There’s an understanding that reliance on stretched supply chains puts you at risk.” That implies the promise of much more serious inflation in places where the jobs go, and of deflation where the jobs leave.

So try to grasp the scale and pace of structural changes occurring in the environment in which inflation is, or isn’t, created. For now, everything is upside-downton, but where it ends up(ton) is still an open question. Is a mechanistic return to a 2% CPI trend our future reality or already ancient history?