Inflation – Be Careful What You Wish For
By Damon Gascon, Vice President of Regional Planned Communities, Lewis Management Corp. and member of Pathfinder Partners Advisory Council
“In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could.”
– Rudiger Dornbusch
For the past seven years, central bankers have bombarded the world with unprecedented levels of acronyms – Quantitative Easing (QE), Zero Interest Rate Policy (ZIRP) and Negative Interest Rate Policy (NIRP), which has produced a significant amount of inflation in equities, real estate and bond prices, particularly in relation to income and GDP growth. Now, all that money printing has begun to spill over into core consumer prices.
In the U.S., the core Consumer Price Index (CPI), which excludes food and energy, has risen 2.3% year-over-year, which is the largest increase since May 2012, and well above the Fed’s 2% inflation target. And if you dig deeper, you will find that prices of medical services, shelter cost, tuition, day care and general services have increased by 3.0% to 3.6% year-over-year. The inflation trend is clearly upward.
The primary drivers of the increase in the core CPI are rising wages and slowing productivity. Labor costs increased 2.3% over the past year. Further, minimum wages are on an upward trend in the country with Seattle, California and New York all having passed legislation to increase the minimum wage by 50% from 2016 to 2021. Unfortunately, legislation doesn’t work for productivity. The latest quarterly Bureau of Labor Statistics (BLS) non-farm business sector productivity decreased 1% and has been on downward trajectory for more than a decade. With the possible exception of medical services, the U.S. is experiencing cost-push inflation.
If wages were increasing due to rising productivity and GDP, businesses and policymakers would receive a standing ovation. Real median incomes for the lower and middle-income segments of American workers have been hammered over the past two decades. However, wage increases are being driven more by populist political rhetoric rather than sound economic policies.
This brings us to the Fed. The fundamentals of the U.S. economy indicate a clear case for further rate hikes. Unemployment is down to 5%, job growth is strong and consistent. The trend in core inflation suggests that the Fed is falling behind the curve with core CPI at a post-crisis high. Yet the Fed’s recent rhetoric remains dovish.
Recent remarks from Fed Chair Janet Yellen, indicate that she believes that there is still considerable slack in the labor market and the economy has greater capacity for above trend expansion without generating much inflation. An interesting theory but the inflation data does not support Yellen’s logic. The fact is that the domestic economy is no longer the Fed’s sole consideration in policymaking. In an environment where central bankers around the globe seem unable to raise interest rates (and many have lowered rates – some below zero), the Fed has all but explicitly recognized a new mandate: promoting global financial stability.
Messaging from financial markets increasingly influences the Fed’s decision-making. Any suggestion that the Fed will hike faster or earlier than anticipated leads to violent risk-off moves in financial markets. It is clear that the Fed could not stomach the sell-off in global financial markets in January and February, which was largely driven by concerns about further tightening. The implications are worrying. A Fed beholden to financial markets risks sharper rate hikes down the road as the Fed falls further behind the inflation curve. As Oscar Wilde wrote, “In this world, there are two tragedies. One is not getting what one wants, and the other is getting it”.
Damon Gascon, a member of Pathfinder Partners’ Advisory Council, is a 20-year veteran of the homebuilding industry with substantial experience in strategic planning, land development and development of master planned communities. He can be reached at Damon.Gascon@lewismc.com.