And just like that... it was gone.
It may be a wee bit premature to wave goodbye to the above-target inflation rates that have blighted western economies for the past three years.
But it looks increasingly wide of the mark to argue that the episode has firmly entrenched expectations of higher inflation.
If expectations have been firmly “re-anchored,” a large part of the central banks’ recent battle has been won and the only risk is that they now leave it too late to ease credit again.
On Monday, the New York Federal Reserve’s latest household survey showed that the median 3-year inflation outlook has fallen to the lowest point in the 11-year history of the series. It is now just 2.3%.
To be sure, inflation forecasts over other time horizons were nearer to 3%, but the whole survey is basically eliciting the same responses that it was in the years before the pandemic. This may suggest that the “old normal” has returned to some degree.
Declining cost pressures on small businesses also indicate the price pain may be dissipating even as confidence in the wider economy improves.
While July’s NFIB survey showed high inflation remains the single most important problem among small firms, it also noted that the net number of them planning price rises has fallen to the lowest point since April 2023. The number of owners expecting to raise employee compensation is also at the lowest level in three years.
And financial markets have virtually pulled the plug on above-target inflation expectations as well.
“Breakeven” inflation assumptions embedded in Treasury-protected securities subsided to within a whisker of the Fed’s 2.0% target last week on both 5- and 10-year trajectories . That was the lowest in more than three years.
True, pricing in the so-called TIPS market can get distorted by the ebb and flow of bond market speculation or demand-related over-valuation. But the 5-year-forward inflation-linked swaps showed a similar-sized drop last week as well.
At 2.44%, the swap has lost 15 basis points this month alone and is some 35 bps below the long-term inflation reading it suggested as recently as April.
HOT AND COLD
Bank of America’s latest global fund manager survey showed a rapid reduction in managers identifying higher inflation as the biggest risk to portfolios.
While as many one-in-three said it was the biggest “tail risk” in July, only one-in-eight thought so this month.
Could energy prices shift the whole dial again?
There is little doubt about the power of oil and gas prices to affect inflation and fears of it. That much was clear after the 2022 Ukraine invasion.
But crude prices have been down on a year-on-year basis for the first sustained period since February. And those base effects will bear down on headline inflation for months to come.
Also, an energy-driven spike in inflation seems highly unlikely if there is parallel fear of recession sapping oil demand.
While the number of BofA survey respondents expecting a “hard landing” for the economy over the next 12 months remains low, it crept up this month to 13% - its highest point since January.
So one of the big questions is whether all the hoopla about a post-pandemic “Great Inflation” or world economies “running hot” for years was just hot air itself?
University of California, Berkeley professor Brad DeLong recently puzzled over why the market’s implied inflation picture changed so suddenly.
“The marginal TIPS-nominal Treasury arbitrageur looks to be taking the ‘economy runs too hot over the next five years’ scenarios off the table,” DeLong wrote in a blog.
Going further, he suggests the Fed may actually face the risk of undershooting its inflation target for much of the next five years, if implied inflation rate in markets at around 2% is an average and over that time and with current rates still between 2.5% and 3.0%.
If investors really do think the Fed now faces years of potentially undershooting its target again, then must also be entertaining the chance of some return of the “secular stagnation” theme that haunted the pre-pandemic era.
And if that is correct, then the Fed may well have kept things too tight for too long already.
On one hand, last week’s spike in market volatility showed how changeable markets can be with even a minor catalyst.
But even accepting market twists and turns, there is clearly little in public or corporate surveys to suggest high future inflation is seen a major problem.
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