over 1 year ago • 2 mins
It’s not just central bankers who badly underestimated how high and persistent inflation would be. Investors did it too. The problem is: they might still be doing it.
The chart above shows what has happened historically after inflation hit 8% (to the right of the zero bar). Here, you’re looking at the 126 times inflation has peaked above 8% since 1970. The shaded light blue area shows the core range of monthly inflation results, stripping away the top and bottom 25 percentiles, so you get a clearer read of what’s happened without the kinds of distortions that can occur with an outsized, temporary move. The dark blue line, meanwhile, plots the median rate of inflation for those times.
Now, compare those to what economists currently expect for US inflation (red dotted line) and European inflation (gray dotted line).
One thing’s quite clear: if history’s any guide, it’s unlikely that inflation will fall back as quickly as the consensus of economists currently expect. In fact, it appears more likely that inflation will keep rising for a few more months and take a lot longer to get back to its previous levels. In other words, you could anticipate inflation lingering between 6% and 12% for the next two years.
The one thing that could send inflation far lower far quicker: a complete collapse in growth and a deep recession. And that’s arguably a real possibility: the Federal Reserve has never been quite this aggressive in rate hikes before, and there’s a long lag between the hikes themselves and the impact they have on the economy. So, while these hikes might bring down inflation, that wouldn’t likely be good news for risky assets like stocks as their earnings would likely be badly hit in a deep recession.
One thing’s for sure: inflation’s not likely to fall by itself. The economy would have to slow down sharply – and its current resilience suggests that more aggressive hikes might be required before that happens. As long as inflation remains high, there’s no easy way out of this mess.
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