December Inflation Jumps, Casting Doubt on Soft Landing Base Scenario

Shaking off some of the optimism for a direct path back to 2% CPI, the headline number took a meaningful jump back up to 3.4% after a solid downtrend since August. Restaurant CPI was essentially unchanged, with a basis point blip down but continuing to remain above 5%.

Stabilizing Higher

The prevailing narrative over the past few months has been that of turning the corner to the elusive ‘soft landing’ where inflation returns to 2% without the Fed running the economy into a ditch. Certainly, the economy is in much better shape that most people (including myself) predicted a year ago, with employment & consumer spending remaining strong despite the pressure of higher interest rates. But perhaps a different narrative is starting to emerge, that will never actually be uttered by the Fed or any government officials – and that’s one where 2% inflation is not really a target anymore. Here are 2 reasons why that might be changing:

1.     Debt Devaluation: Above average inflation (perhaps 2.5--4%) over a good stretch of time doesn’t looking so bad when you’re sitting on a massive pile of debt. The best way to cover that debt, and the way it’s been done after every major crisis for at least the past century is to make the debt worth less while increasing your revenue. Inflation accomplishes both of these goals – but if the economy slows if hits the brakes on revenue growth, blunting the effect. Too much inflation makes people really angry and leads to instability – but the right dose is how governments bail themselves out of spending binges faster. The Fed can’t give any indication that any target has changed, because inflation expectations drives more inflation – so if you believe I’m right, then I just might be an inflationary catalyst…

2.     De-Globalization: Whether you like globalization or hate it is irrelevant. Global trade has consequences, positive and negative – I don’t care to argue the politics of which benefits are worth which costs in this post. As it pertains to inflation – in or around 2018 international trade began to reverse for the first time since the 1940’s. More trade and lower tariffs makes things less expensive, more tariffs and less traded makes things more expensive. That is not debatable. What is a fair debate is the question of tariffs and whether the other benefits are worth the cost of higher prices. If the world has entered an extended period of de-globalization, which it appears to the case – then maintaining the low inflation of the late 20th century is probably unlikely. It doesn’t mean we are destined for hyper-inflation – but normal might end up being something meaningfully higher than what we’ve become used to. On the other hand, if de-globalization and isolationism is just a temporary diversion than old trends would likely hold.

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