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Fed and US corporates in tussle over inflation

The release of record-busting US CPI-inflation data for October has seriously dented the Federal Reserve’s long-standing argument that high inflation will prove “transitory. What has proved transitory is the rally in short-end government bond yields in developed markets, in line with our expectations.

Volatile monthly inflation in the US and fleet-footed developed central banks point to government bond yields remaining choppy near-term. However, we think the likelihood that US inflation will rise further in coming months will lift short-end Treasury yields and where US Treasury yields go other government bond yields tend to follow, even if reluctantly.

US CPI-inflation rose much faster than expected in October and in the process broke a number of three-decade old records. In analysts’ defence monthly CPI-inflation data have been very volatile this year and thus difficult to predict, as we noted back in September.

Encouragingly for the Federal Reserve the monthly pace of headline PCE-inflation gradually slowed from April to September. However, our analysis suggests that PCE-inflation, including the central bank’s preferred core measure, picked up in October.

Moreover, we estimate that core PCE-inflation, which excludes food and soaring energy prices, will have to average only 0.2% mom between November 2021 and December 2022 (versus 0.4% mom in April-September 2021) in order for the year-on-year rate to be broadly in the middle of the Federal Reserve’s forecast range of 1.9-2.8% for end-2022.

Unfavourable base effects no longer explain elevated year-on-year inflation, with US inflation now well above the pre-pandemic trend.

US companies have rapidly raised the prices they charge customers, particularly for goods, because they have had to as a result of rising input costs and importantly because they have been able to without hurting their bottom line thanks to robust US consumer demand, particularly for goods.

The Fed has little control over international energy and commodity prices and coincidently is seemingly intent on letting consumer demand (and the economy) run hot for a while.