In light of Fed Chairman Powell’s congressional testimony, we thought it relevant to revisit the inflation story and provide yet more evidence that the trend in inflation continues to be higher. For now, the Fed has assessed the risks to inflation and growth as balanced in both directions, which is Fed-speak for a policy that is on auto pilot. Yet, a number of indicators spanning the labor market to input costs suggest the risks to inflation, at least, remain squarely to the upside. Not that this will necessarily affect Fed policy. After all, the Fed has recently introduced the concept of inflation symmetry, which is the idea that if inflation ran below target for an extended period then perhaps it should run above target for an extended period as well. But a continued trend of higher inflation would surely inform asset allocation decisions of portfolio managers from the types of equities to be invested in to the magnitude of one’s commodity exposure. With that, let;s get to the charts.
One of our favorite indicators of trend inflation is the New York Fed’s Underlying Inflation Gauge. It includes not only measures of prices, but also macroeconomic and financial market variables in order to capture the true trend of economic pricing pressure even more acutely than the Core CPI. Interestingly, the Underlying Inflation Gauge (blue line) leads Core CPI (red line) by 16 months and is doing nothing but going up and to the right. If this were a stock, you would want to own it.
The long-awaited increase in wages also seems to be unfolding, and indicators suggest it has legs. The next chart below compares average hourly earnings (blue line, left axis) to the ratio of quits to total separations (red line, right axis), two components of the Job Openings and Labor Turnover Survey (JOLTS). Voluntary quits as a percent of total employment separations can be thought of as one measure of wage pressure, since people generally only voluntarily leave a job for another higher paying job. Therefore, the fact that this ratio has exploded higher so far in 2018 suggests that faster wage growth is not far behind. In fact, the quits to separations ratio leads wage growth by about one year.
Other under-the-surface measures of wage growth also suggest higher earnings in the year ahead. Here we plot average hourly earnings (blue line, left axis) against small business hiring plans (red line, right axis). Small business hiring plans lead wage growth by about 15 months, and while they aren’t making new highs, they certainly are not far off of the highs. This suggests continued wage pressure.
The next chart shows one measure of cost-push inflation, import prices (blue line, left axis), compared to the CPI (red line, right axis). Clearly a healthy relationship exists between these two series. If tariffs on iron, steel, Chinese goods and possibly even autos have an impact on import prices, which we fully expect them to, this would put significant upward pressure on overall import prices and drag higher the CPI with it.
One final measure of pricing pressure comes from the Citi Inflation Surprise Index. It troughed in early 2015 at -40 and has since moved to just -3. In other words, economic measures of inflation are no longer missing expectations. Rather, they are squarely meeting expectations at a time when actual inflation is moving higher, meaning that economists too believe that inflation is accelerating. If underlying trends in inflation, wage growth, or input prices put more upward pressure on prices, as the data suggests, inflation surprises may start moving higher too, which could take the financial markets by surprise.