Inflation, which is a loss of purchasing power, is likely to stay elevated thanks to a variety of structural forces.

The Labor Department reported an 8.3% year-over-year increase in the total Consumer Price Index (CPI) for August. It was a bigger gain in inflation, which is a loss of purchasing power, than expected. Economists and financial strategists agreed that the latest data show inflation is sticky.

Sticky inflation is underlying inflation, or inflation in areas where prices tend to change relatively slowly. Additionally, inflation is structural, meaning the floor is higher than many might assume, and the potential implications go beyond recession.

Vincent Deluard, director of global macro strategy at StoneX Financial, says the current period of inflation is the result of three shortages: labor, energy, and trust.

• Labor. The U.S. labor market is still about seven million workers short of pre-pandemic levels.
• Energy. The transition to green energy requires moving down the energy-density ladder for the first time in history, meaning the green transition will consume more resources for similar output. And, when withdraws from the strategic petroleum reserve (SPR) stops, it will remove a downward force on oil prices.
• Trust. Inflation is inversely proportional to the level of trust between a country’s citizens. “Inflation is a fever that tells you an economy has an underlying ailment of weakening trust, then the fever weakens the body, and it all worsens,” opined Deluard. Inflation is “always and everywhere a psychological phenomenon,” where the problem worsens the longer it persists, Deluard states, as he modifies Milton Friedman’s take on inflation.

Additionally, the August’s CPI report puts the “peak inflation” assumption into question and shows that the labor market and demand -– not supply — problems are driving price increases.

More volatile inflation in categories such as food and energy, which economists and policy makers back out of inflation readings to get to what they call core inflation.

The Fed’s attempt to front-load interest-rate increases is one attempt to regain public trust and restore price stability. The “transitory” inflation argument that has been retired in speeches but not in spirit.

Investors, and central bankers themselves, may therefore be underestimating what the Fed must do to curb inflation, while simultaneously underestimating the odds that inflation remains well above 2% for longer.

References:

1. https://www.barrons.com/articles/inflation-cpi-labor-shortage-energy-prices-51660265410
2. https://www.barrons.com/articles/cpi-inflation-report-july-2022-data-51660078098?mod=article_inline