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Why is Inflation Making a Big Comeback After Being Absent for Decades in the U.S.?
Mar 24, 2022
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7 min read
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| 1 Introduction |
In February 2022, the U.S. inflation hit a fresh 40-year high as its consumer price index (CPI) accelerated to 7.9% year-on-year. Prior to the Covid-19 pandemic, inflation was almost non-existent in the U.S. since the 1980s. In this research paper, we will look into a myriad of factors that contributed to the current higher-than-expected inflation in the U.S., the similarities and dissimilarities compared to past occurrences as well as how they were brought under control in the past.
| 2 Contemporary Inflations in the U.S. Post World War II |
Since the end of the World War II (WW2) in 1945, the United States (U.S.) has gone through several heightened inflation cycles that had resulted in economic hardship. Some of the pronounced cycles are: -
- 1946 ~ 1948 – When the WW2 was over, rapid inflationary pressure was caused by pent-up demand and supply shortages in addition to elimination of price controls. Factories had to significantly increase production to meet the demand.
- 1950 ~ 1951 (The Korean War) – Americans were anxious over another prolonged war and started to hoard goods due to fear of the rationing and supply shortages that had occurred during the WW2. Additionally, some consumer production shifted back to military materials and price controls were reinstated. However, inflation quickly normalised and was not prolonged once the war was over and price controls were removed, unlike the way it soared post-WW2.
- 1973 ~ 1982 – Increase in cost of production due to depreciation of the U.S. Dollar following the collapse of the Bretton Woods System. During this time, crude oil prices surged as a result of the oil embargo imposed by the Organization of Arab Petroleum Exporting Countries (OPEC) coupled with a decline in oil production due to the Iranian Revolution and the Iran–Iraq War. The Federal Reserve (Fed) chairman Paul Volcker had to aggressively hike interest rates to bring the inflation under control. It was also during this period that employers had to bow to workers’ demand by increasing wages as the clout of labour unions gained prominence. However, the role played by labour unions started to diminish as the U.S. President Ronald Reagan took a hard stance against them—in particular, clamping down the strike organised by air traffic controllers. Businesses began hiring and production increased. Hence, the inflation was subsequently contained.
.PNG "US Inflation Rate (Y-O-Y)")
Source: FRED and BPAMChart 1: U.S. Inflation Rate (Y-O-Y)
| 3 Why Inflation Was Under Control in U.S. for the Past 40 Years until Recently? |
After the elevated inflation was brought under control by Paul Volcker’s aggressive rate hikes in the late 70’s and early 80’s, inflation in the U.S. has become benign ever since. This could be attributed to the following few factors: -
- Effects of globalisation as productions were shifted to countries with cheaper labour cost, i.e., developing countries like the South American and Southeast Asian countries. This phenomenon was more pronounced after the accession of China into the World Trade Organization (WTO) in 2001, which serves as the world’s factory.
- Advancement in technology also played a major role in bringing down the cost of doing business. This was evident from the widespread adoption of the Internet technology in the 90’s that culminated in the Dotcom bubble. Despite the ultimate Dotcom bubble burst, consumers’ and businesses’ transition into the digital and virtual space was irreversible. For instance, e-commerce giants like Amazon and Shopify have enabled cheaper products and services to be delivered to consumers while online streaming giants like Netflix and Spotify have made entertainment more accessible and cheaper than traditional methods.
| 4 Recent Bout of Inflation Post Pandemic |
From 2021, the heightened inflationary pressure was caused by global supply chain disruptions as a consequence of lockdowns imposed by exporting countries such as China and the Southeast Asian countries during the Covid-19 pandemic.
The whole situation was aggravated by the Fed’s quantitative easing (QE) programme in addition to the massive fiscal stimulus packages introduced by the U.S. government. Ordinary folks have more money to spend due to the stimulus payments amid a surging equity market as a result of the QE programme. An increasing number of people chose to retire early in view of the on-going pandemic that in turn caused labour shortages. Labour shortages played a major role in the escalating shipping cost as the turnaround time at seaports has increased substantially.
Besides, U.S. President Joe Biden’s green energy initiative has also caused global crude oil prices to creep up when he signed the executive order to revoke the permit for the Keystone XL pipeline on 20 January 2021—the day he was inaugurated. Previously under President Trump’s administration, U.S. had become a net exporter of oil again in 2019/2020, attributed to Trump’s pro fossil fuels energy policy so that the U.S. could become self-sufficient in energy.
The soaring crude oil prices worsened when the Russian invaded Ukraine in February 2022 as the U.S. and its allies announced economic sanctions that include the banning of the Russian energy imports as well as halting the approval of the Nord Stream 2 gas pipeline from Russia to Germany. Both WTI and Brent crude oil prices soared past USD100 per barrel in an instant as fears of a global energy supply disruption mounted.
Source: EIA and BondStreamChart 2: Crude Oil Prices
| 5 U.S. Treasury Yield Performance |
The 10-year U.S. Treasury (UST) yield has been trending above 1.5% for years before the Covid-19 pandemic wreaked havoc globally in the first half of 2020. Owing to the Fed’s asset purchase / QE programme and drastic Fed funds rate cut to between 0% and 0.25%, the 10-year UST yield dropped drastically below 1% from March 2020 before recovering to above 1.5% a year later in March 2021 due to higher inflation expectations.
That being said, the rise in the 10-year UST yield has lagged behind the rapid increase in the CPI attributed to the dovish Fed that viewed the heightened inflationary pressure as transitory throughout most of 2021. However, bond investors were caught off guard by Fed chairman Jerome Powell in December last year, when he unexpectedly acknowledged that the inflation was much more severe than he had earlier anticipated. His rhetorics could pave the way for a more contractionary monetary policy to rein in the inflation.
Besides, in view of the current Russian energy sanction, inflation may jump even higher before the West could find alternative energy sources. That could entail a higher UST yield in the near future amid a hawkish Fed.
Source: FRED, U.S. Department of the Treasury, BPAMChart 3: CPI, 10-Year UST Yield and Spread
Source: BPAM: Why is Inflation Making a Big Comeback After Being Absent for Decades in the U.S.? (2022, 22 March). BPAM MARKET AND PRODUCT RESEARCH. Retrieved from BPAM
The information provided in this report is of a general nature and has been prepared for information purposes only. It is not intended to constitute research or as advice for any investor. The information in this report is not and should not be construed or considered as an offer, recommendation or solicitation for investments. Investors are advised to make their own independent evaluation of the information contained in this report, consider their own individual investment objectives, financial situation and particular needs and should seek appropriate personalised financial advice from a qualified professional to suit individual circumstances and risk profile.
The information contained in this report is prepared from data believed to be correct and reliable at the time of issuance of this report. While every effort is made to ensure the information is up-to-date and correct, Bond and Sukuk Information Platform Sdn Bhd (“the Company”) does not make any guarantee, representation or warranty, express or implied, as to the adequacy, accuracy, completeness, reliability or fairness of any such information contained in this report and accordingly, neither the Company nor any of its affiliates nor its related persons shall not be liable in any manner whatsoever for any consequences (including but not limited to any direct, indirect or consequential losses, loss of profits and damages) of any reliance thereon or usage thereof.
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