More Evolution Than "Pivot"

Chief Economist Scott Brown discusses current economic conditions.

In his congressional testimony of November 30, Fed Chair Powell seemed to shift from cautious to hawkish. However, the evolution of the inflationary outlook had been underway for a while. The spike in inflation in the spring was narrow, the gain concentrated in a few categories. In contrast, the October Consumer Price Index report noted that the 0.9% increase in the headline figure was “broad-based.” The Trimmed-Mean CPI also reflected a wider range of component price increases, a sign that inflation was becoming more rooted. That is especially troublesome for Fed policymakers. The November CPI report reinforced the view that higher inflation has broadened out.

A month ago, financial market participants reacted to the stronger-than-expected CPI increase, but most missed the key point. It wasn’t that inflation was running higher than anticipated. The real concern is that higher inflation is becoming more rooted. Price hikes have broadened across categories. This was corroborated by the Fed’s Beige Book (December 1), which reported that “prices rose at a moderate to robust pace, with price hikes widespread across sectors of the economy.” In November, the CPI rose an additional 0.8% (+6.8% y/y), “the result of broad increases in most component indexes,” according to the Bureau of Labor Statistics.

The Beige Book noted “wide-ranging input cost increases stemming from strong demand for raw materials, logistical challenges, and labor market tightness, although “wider availability of some inputs, notably semiconductors and certain steel products, led to easing of some price pressures.” More troublesome, “strong demand generally allowed firms to raise prices with little pushback.” A lack of pricing power has been a long-standing fixture of the U.S. economy, and has been especially problematic for manufacturers (who have often faced higher input costs in recent decades and greater competition from cheaper imported finished goods). An increase in pricing power, as appears to be happening, would reinforce higher inflation.

The labor market is far from fully recovered, but labor market conditions are tight. Labor force participation is a major uncertainty in the 2022 economic outlook. We saw an uptick in participation in November, following little change over the 12 previous months. Dependent care issues (mostly childcare, but also elderly care) have been a constraint, and while we should see some improvement, this will continue to be a factor in 2022. Higher wages could help to keep older workers from retiring, but a gray wave is likely to continue regardless. We could be surprised, but labor force participation seems unlikely to return to pre-pandemic levels.