Heading for double-digit US inflation

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

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  1. John Hall

     /  April 29, 2021

    I would probably use Divisia indices, rather than M2/M3.

  2. Martin

     /  April 30, 2021

    Tak for altid fremragende og meget spændende analyser, Lars. Både her men også diverse videoer og podcasts, hvor du deltager. En stor fornøjelse at lytte på!
    Hvordan ser du renteudviklingen her i DK? Nu har vi har siden Januar set den lange rente stige og vi har nu på realkreditten en 1,5 % 30 årig som aktuelt lån. Et par spørgsmål:
    1) Hvor langt ser du vi kan gå op i rente på realkreditten over de kommende mdr., slut 2021, og evt 2022?
    2) Du har nævnt senest, at den faldende lange rente vi har set siden GFC, den udviking havde vi set alligevel pga demografien og ikke så meget pga QE fra ECB. Når det her inflationsfokus forsvinder om ex. 1,5-2 år, ser du så den lange rente falde igen de kommende mange år efter de her stigende renter? Trenden på den lange rente har jo i mange år bare været nedad (Igen, aldrende befolkning og stigende opsparinger) med korte perioder med stigninger.

  3. Alex S.

     /  April 30, 2021

    Also, in addition to the Divisia measures (http://www.centerforfinancialstability.org/amfm_data.php), IHS Markit has a monthly NGDP and RGDP series that is publicly available here: https://ihsmarkit.com/products/us-monthly-gdp-index.html

  4. Giordano Felici

     /  June 16, 2021

    Very good job. I have only one request, since I’m an undergraduate student in economics that recently tried to do the same job you did in this post. I tried to evaluate the P-star but I obtained different results, since there is a sharp increase in the p-star level but does not fit the simulation you did. Since I’m interested in those topics, because of the fact that I want to include my own estimation of the P-star level for my bachelor’s thesis, I’d like to know why I obtained those slightly different results. For my estimation of V*, for example, I used the NGDP/M3 ratio and then I have de-trended that and for Y* I used the Potential GDP estimated by FRED data, as you suggested in a previous post. So I don’t understand why – following your suggestions about how to run this model – I do not obtain the same results. I would very appreciate your clarifications and I’d like to thank you in advance for the help!

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