The inflation rate ticked up to 1.4% in December and the yield on 10-year Treasuries remained above 1% for the sixth straight day on Wednesday. These levels should be considered small victories in the normalization of the economy after a rough nine months of the pandemic.
At this point, rent for shelter continues to deflate and a variety of core metrics that are sensitive to monetary policy remain well below the central bank’s target of 2%.
This implies that there is plenty of fiscal and monetary space to support the post-pandemic economic recovery and underscores our view that the Federal Reserve will not lift its policy rate, which is effectively at zero, until 2024.
Inflation has not been an issue since the 1990s. With energy prices and wage gains continuing to moderate, inflation expectations continue to coalesce around the 2% target.
This outlook can be explained by a combination of the advancement of monetary policy, technological advances in both fossil fuel extraction and alternative energy and conservation, as well as the development of the global supply chain and a global labor market.
We have made the case for some time that changes in the underlying structure of the U.S. economy permit it to run above the long-term trend growth rate of 1.8% for several quarters without generating significant inflation. Recent inflation data continue to underscore that view.
At the same time, excessively low rates of inflation are symptomatic of insufficient demand and low-growth economies (think Japan). That the inflation rate has moved from 0.1% in May to 1.4% at the end of the 2020 gives hope that the economy will avoid a deflationary spiral and a recessionary relapse.
This is one reason why we think the coming increase in fiscal outlays will not increase the risks to the domestic economic outlook linked to inflation or interest rates.
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