I have spend a lot of my time since 2008 arguing that US monetary policy was much less expansionary than most people thought and has been arguing for a more aggressive response from the Federal Reserve to combat deflationary pressures.

Furthermore, I have last year welcomed the Fed’s policy respond to the lockdown crisis – see for example here – as I feared a repeat of the deflationary shock of 2008-9.

Furthermore, even though I have been somewhat worried about the sharp pick up in US broad money supply growth I for while was of the view that breakeven inflation rates were quite low and as a consequence we should not worry too much about inflation.

However, over the last couple of months I have become more and more convinced that particularly elevated stock prices, property prices and commodity prices reflected sharply increased inflation pressures.

I have therefore, gradually changed my view on inflation and am now quite convinced that inflation will pick up very strongly in the US. In fact, I now seriously fear that we are heading for double-digit inflation in the US before the end of this year.

I has taken me a lot of time to spell out this view publicly because I full well-know that this certainly is not the consensus view and it is certainly not (fully) priced – at least not by fixed income markets. As somebody who tend to believe markets are close to efficient I don’t lightly second-guess the markets, but I have also convinced myself that this ‘mis-pricing’ in particularly in the fixed income markets at least to some degree reflects a massive liquidity effect that ‘overshadows’ rising inflation expectations.

But today I call it – the US is heading for double-digit inflation in 2021 and it will happen very fast. What I expect is not necessarily permanently higher inflation, but rather a sharp one-off jump in the US price level.

What happens after this starts to unfollowed I believe is a lot harder to forecast and it will strongly dependent on the Fed’s response to this jump in the price level. One possibility is that we will see a serious erosion of Fed’s credibility and longer-term inflation expectations will jump. Alternatively the Fed moves aggressively to curb rising inflationary pressures and is able to convince the markets that this is indeed a post-pandemic one-off jump in the price level, but not permanently higher inflation.

No matter what this is likely to be THE main topic for global financial markets in 2021 and I have a hard time seeing this playing out without causing some volatility in global financial markets.

I am very hesitant even calling this a “forecast” for US inflation. Rather it is a simulation of what we should expect to happen to the US price level if Fed allows the ‘liquidity overhang’ to feed fully through to prices. I doubt that will happen but on the other hand the Fed seems to be ‘deliberately’ behind the curve so at least for the next 3-5 month we are likely to see a very sharp increase in the price level.

Below is my ‘simulation’ for US inflation.

This simulation is based on the so-called P-star model.

In a Twitter thread earlier today I discussed the model and the implications for US inflation and partly the implications for asset prices.

See the discussion below.

Again, I don’t make this forecast lightly. There is a lot of things that can change to change the outcome, but again and again over the last couple of months I have postpone making this forecast because I know it is a rather wild prediction, but I can no longer find excuses not to make this forecast because I fundamentally believe the analysis is correct and I have to follow the logic of the analysis and the numbers and the only conclusion I can reach is that we are in for a very sharp increase in US inflation – very soon.

I am as always happy to discuss the my analysis with clients and potential clients. Contact: lacsen@gmail.com