Economic Insights: Is inflation dead?

Is inflation going, going, gone? Has the scourge of the 70’s been eradicated or are we at a significant inflection point in the cycle?

March 19, 2019

Is inflation dead? We do not pose that question in a literal fashion, but we do not mean it rhetorically either. Both globalization, which emerged as a serious force over the last two decades (despite recent pushback against it) and the power of central banks (notably the Fed) in recent decades, have combined to tame inflation. Globalization outsourced production to places and technologies that drove down costs while central bankers adroitly manipulated interest rates and inflationary expectations. But have they gone too far and killed inflation? Inflation once roamed as a scourge in the 1970s that prompted central banks to undertake its management seriously. In recent years the opposite holds — inflation struggles to reach central bank target rates around the developed world.

First, a look at some data. Last week brought us fresh reading across a variety of inflationary indexes. The headline consumer price index (CPI) for February increased on a monthly basis for the first time since October, helped by resurgent energy prices. Both the headline rate and core rate declined slightly year over year, with headline sliding to 1.5 percent while core pulled back to 2.1 percent. Meanwhile the February producer price index (PPI) showed something very similar. The monthly headline rate increased slightly while both the headline and core rates declined marginally on a year-over-year basis, falling to 1.9 percent and 2.3 percent respectively. Finally import prices increased in February, boosted by energy, but the year-over-year rate held firm at 1.3 percent.

While prices gradually rose during the current expansion, context matters. Inflation remained low despite historically low interest rates and increasing (and importantly circulating) money supply, two things that theoretically should have propelled prices upward. Intensifying globalization almost certainly played a key role in keeping inflation in check. In more recent periods rising rates have helped to tamp down inflation despite accelerating wage growth. We now stand at an important point: the Fed sits on hold, wage growth is still accelerating, productivity growth will likely decelerate in 2019, and the blowback against globalization is causing some of the integration of the last few decades to reverse. Could the interplay of these three factors finally put meaningful pressure on upward prices? That looks possible, but this year could provide ample evidence toward answering the question of whether or not inflation died. Inflation expectations vary but have slowly risen in the last two years.

Data from January shows that the death of retail was greatly exaggerated.

Return of retail

Retail sales presented good and bad news. On the negative side, not only did we receive confirmation of December’s dour retail sales, but the figure was revised further downward. It appears as if the combination of the correction in the equity market, government shutdown, and concern over trade restrictions limited consumers’ willingness to spend in December. Holiday sales grew by just 2.9 percent, coming in well below expectations. But we see this as a temporary disruption. On the positive side of the ledger, data from January shows that the death of retail was greatly exaggerated. Both headline and core retail sales figures bounced back firmly after December’s dispiriting data. With the labor market remaining tight and job growth continuing, we expect further growth in retail sales in 2019. Consumer sentiment for March supports this view — the rebound exceeded even optimistic expectations.

What we are watching this week

More than a couple of data releases, the Fed’s meeting will attract attention. While we expect no movement on rates, the markets will look at the statement and any commentary from the Fed to determine if it has turned even more dovish. Any sign that the Fed will take an even softer approach will likely get cheered by markets. Any indication that hawkishness is making a comeback will likely receive a cold shoulder from markets. The Fed could make a proclamation on the end of quantitative tightening (QT), possibly even by the end of this year.

What it means for CRE

For commercial real estate (CRE) the temporary disruption in consumer spending should not impact the asset class much. Most viewed the sales data from December as an anomaly if not an outright error and market participants have already moved on. With interest rates hikes likely on hold until the fall, we do not see this week’s meeting have a large impact one way or another. It could create some noise in markets, but not much signal. Inflation expectations, on the other hand, pose a complex set of issues for CRE. Inflationary readings to date have not meant much to the sector. Depending upon how this year unfolds, inflation could become a boon or a nonfactor for CRE. Accelerating inflation could reaffirm the classic argument in favor of CRE but could also result in a greater number of rate hikes than the market is currently anticipating. We expect only modest net impact from inflation in 2019, but the path forward for inflation remains uncertain.

Thought of the week

While the NCAA men’s basketball tournament generated over $1 billion in revenue in 2018, it also reduced productivity. Estimates vary, but the negative impact likely totals in the billions of dollars in lost output.

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