The recession appears to be behind us in the United States and the early stages of an economic expansion have been taking shape. There is a growing debate over whether an expanding economy may cause inflation to overheat. This begs the question, will we see a reflationary environment—where prices merely normalize to prior levels or outright inflation—where consumer prices begin to increase above trend?
Last week's consumer price index (CPI) release may have put some of those concerns about inflation to rest—at least for now. US CPI rose 0.3% month over month in January, where rising gasoline prices accounted for the bulk of the increase in the headline index. Core CPI (which excludes volatile food and energy prices) was flat on a month-over-month basis.
Broadly speaking, we think inflation jitters are unlikely at the present juncture. The Philips curve—a measure of the relationship between the unemployment rate and inflation, has flattened over time, suggesting that the US economy is able to tolerate lower levels of unemployment before the labor market causes inflation to heat up—for example, the environment we saw in 2019 when the unemployment rate crossed below 4% without triggering inflation.
As shown in the chart below, the unemployment rate remains quite high at 6.3%, while the number of permanent job losses (those looking for work whose employment ended involuntarily), remains near its pandemic highs:
While inflation may be low right now, base effects from the deflationary environment seen last year will “inflate” the year-over-year CPI numbers over the next few months.
“It’s reasonable for the market to expect inflation to rise from depressed levels, but we’re not expecting inflation to get out of hand,” added LPL Chief Market Strategist Ryan Detrick. “We think we’re more likely to see more of a reflationary environment rather than a truly inflationary environment here in 2021.”
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