US inflation rears its ugly head
THE trigger for the next global recession is at last coming into view after a series of loud distractions and false alarms. The Atlanta Federal Reserve's gauge of "sticky-price" inflation in the US soared to a post-Lehman peak of 3pc in February. This index is a ' pure' measure of core inflation - the underlying story once the noise is stripped out.
The Cleveland's Fed's ' median consumer price index' jumped to 2.9pc, with big rises are in medical services, housing rents, car insurance, restaurants, hotels, women's clothing, jewelry, and car hire. This is the long-feared inflexion point we all forgot about in those halcyon days of deflation, now just a fond memory. The Fed's veteran vice-chairman Stanley Fischer is itching to tighten. "We may well at present be seeing the first stirrings of an increase in the inflation rate," he said in a portentous speech last week.
Every major downturn since the First World War has been caused by the Fed, determined to snuff out inflation as the credit cycle matures. Expansions rarely die of old age. They are killed.
There may have been other factors in each historical episode - the oil shocks of the 1970s, or the first Gulf War in 1991 - but the Fed has been the determining catalyst each time. Mr Fischer could hardly have been clearer. He spelled out why the 1970s 'Phillips Curve' trade-off between unemployment and inflation is alive and well, and an implicit warning that prices could soon off take since the labour market is clearly approaching the electric fence of Milton Friedman's NAIRU (non-accelerating inflation rate of unemployment). The economy created 242,000 jobs in February. The broad U6 unemployment rate has dropped to a cycle-low of 9.7pc. The willingness of workers to switch jobs - the ' quit rate' - has surged since September and is back to 2008 levels.
Higher wage demands will follow as surely as night follows day. The Fed will not raise rates this week with so much fog still in the air. Half the world is in a sulk, the ISM manufacturing gauge still below the boom-bust line of 50, and US retail sales slipped again in February. But be careful. John Williams from the San Francisco Fed says that under any definition of the Taylor Rule - used by central banks to calibrate policy and the output gap - there should be an "immediate increase in rates". It not happening yet because doves first want to see the "whites of the eyes" of coming inflation. That is hardly a comfort.
Markets are still dismissing hawkish talk as bluster, betting that the Fed will not be able to raise rates four times this year as loosely implied by its own ' dot plots'. Futures contracts are pricing in just a 30pc chance of two rate rises. Michael Darda from MKM Partners said markets are remarkably complacent about the Fed, and warned against trying extract much more profit from a tired rally.
"Our working assumption is that we are likely in the last year to year-and-one-half of this cycle. On average, equity markets tend to peak about six months before a cycle peak going back to 1929," he said.
Yet we are in uncharted waters, and exactly where we stand on the monetary spectrum is a hotly disputed subject. "We simply do not see any build-up of late-cycle pressures. We estimate that the US is about two-thirds into the current cycle, and have pencilled in the next downturn around 2018-19," said Societe Generale in a new report.
The oil crash has muddied the waters and disguised the build-up in price US pressures. This distortion will disappear by July or August. The ' base effects' of oil could then start to kick in the other way, pushing up headline inflation as crude recovers to $50 or $60 by the end of the year - a plausible hypothesis as output rolls over in Russia, the North Sea, Nigeria, Algeria, and the US shale belt.
A bizarre feature of the market panic over the New Year was the widely-held belief that cheap oil would push the world over the edge, setting off mass defaults across the energy industry and a banking crisis as CoCo bonds plummeted. "The stories we were telling each other in markets in January and February involved wild exaggerations and the narrative was heavily inspired by the 2008-2009 financial crisis," Torsten Slok from Deutsche Bank.