There is heightened discussions on inflation especially with the higher than expected April CPI print, but the real focus is on the issue of transitory inflation. The Fed has fostered this discussion with their argument that there is no need for any preemptive early action even if there is an inflation spike because it will not last. Any inflation fears today should be tempered. This is consistent with market consensus inflation forecasts and inflation breakeven term structures. Overall inflation expectations are higher, but the inflation term structure is inverted. In a year to eighteen months inflation should decline albeit be slightly above 2 percent.
We have listed a set of arguments for transitory inflation in the table below. Many of the transitory inflation arguments make sense and have good foundations. For example, supply chain bottlenecks can lead to higher prices now which should be offset over time. Some labor shortages will be eliminated as pandemic rules are further relaxed. Base effects and inflation dispersion will be moderated over time as we return to pre-pandemic economic behavior.
However, a focus on short-term transitory inflation is a smokescreen versus the core issue of whether current monetary and fiscal policy provides a foundation for a higher inflationary environment. Recent history suggests that any link between money and inflation is weak, and any Phillips curve trade-offs is illusionary, yet these are the questions which have to be addressed for higher long-term inflation. A bet on higher inflation and a monetary policy mistake is against the consensus yet betting on or hedging against extremes is a time honored approach to higher performance. The cost of following the consensus may be very high in this case.
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