Inflation in 2022-2023 – Farrukh Kazmi
Is it here to stay?
By Farrukh Kazmi
In October of this year, the US 12-month CPI inflation rate reached its highest level in the US since 1990, at 6.2 percent year-on-year and I expect the December reading for November CPI to be even worse. Pent-up demand and higher energy prices have been a major factor in the increase but supply chain shortages and increases in other commodity prices also explain more recent increases. A very important question of policy debate is whether the increase in US inflation will be just temporary, as in 2008, the start of a prolonged period of inflation above the 2 percent target, or worse still whether inflation will continue to escalate as it did in the 1970s and early 1980s.
During calendar year 2021 the Federal Reserve has revised up its projections for annual inflation for both this year and next. For PCE (household consumption) inflation, the September median projection for year-on-year inflation in the fourth quarter increased to 4.2 percent for this year and 2.2 percent for next year. Both projections are higher than those made in March: 2.4 percent for 2021 and 2 percent for 2022. While the projections have increased, Federal Reserve members continue to expect that inflation will fall sharply next year. At its November meeting the Federal Open Markets Committee (the body which determines the appropriate stance of monetary policy) announced that it would reduce its monthly purchases of Treasury securities and mortgage-backed securities in a policy known as tapering. But it continued to stress that it felt that the rise in inflation was largely transitory, as reflected in its inflation projections.
We expect inflationary pressure to continue, we are concerned that the fall may not be substantial. But Autumn 2021 Global Economic Outlook predicted that annual US PCE inflation would rise from 1.2 percent in the fourth quarter of last year to 5.1 percent this year and moderate to 2.3 percent in the fourth quarter of 2022. However, we see risks as mainly favoring the upside: should these risks continue they will force the Fed to “Taper” or slow the rate of their bond purchases earlier than expected or even steadily increase the rate at which they do it, ending their stimulus program.
Inflation scenarios for 2022-23
To illustrate the risks, we look at whether inflation and high prices are transitory are here to stay? Once a retailer or company raises prices to combat the supply chain problem, can they really lower them in the future? We think not. I mean will Starbucks
In the benign case, we assume that monthly inflation falls gradually to return to its average level for the five years before the pandemic by June next year and then holds there. The monthly price changes are then translated into year-on-year inflation. On this basis, annual PCE inflation next year would fall to 2.1 percent in the final quarter, close to the Federal Reserve’s median projection.
We examine two other scenarios which are even less comforting. We assume that the size of monthly price increases falls but does not reduce as quickly or as far, so that it reaches twice the pre-pandemic period average next June. In this case, annual PCE inflation would average 3.2 percent in the final quarter of next year. This is have a very negative effect on high multiple growth sectors, mainly tech stocks with high forward P/E ratio’s and benefit cyclical or inflationary sectors such as energy, industrial, high cash flow businesses and even small caps.
Finally, if the pandemic at the current trend continues then people will be less likely to return back to work further extending the supply chain glut causing inflation to persist and the annual inflation in the fourth quarter of next year would be 3.9 percent.
Farrukh Kazmi
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