It’s time for a break from the regular-scheduled non-stop talk about the Iran war and Nasdaq because I’m increasingly worried that the US is headed for an inflation problem.
It’s some consolation that Powell will stick around as a Fed Governor but I think there is a chill on the Fed and it’s reluctant to raise rates. If that remains the case throughout this year when it becomes increasingly obvious that they’re behind the curve, then it risks compounding the problem. Fed funds futures are pricing in just 2.2 bps in hikes this year and 9 bps through mid-2027.
The underlying economy is iffy and that’s certainly not inflationary. Real disposable income was up 0.4% y/y through March and that’s not exactly conducive to consumer spending but the wealthy and stock market gains are promoting spending.
In terms of inflation, the picture alone tells a worrisome picture after Friday’s PCE report.
Here are the things I’m worried about:
1) War costs
This is most-obviously oil but it’s also fertilizer and some other inputs. The White House keeps saying oil prices will tumble when the Strait opens but every day we lose 10-12 mbpd and even when the oil comes back, that deficit remains and it will take longer and longer to back fill, keeping oil prices high.
2) Tariffs
The Supreme Court struck some down and that leaves most countries as 10%. I think the Fed is relying too much on models to indicate how quickly those have been passed through. We’re just now starting to see US domestic steel prices rise due to huge tariffs on imports. Moreover, Jamieson Greer was on TV today highlighting the tariffs that are coming in the summer after US ‘investigations’ on trade partners.
3) Huge deficits continue
US government deficit spending remains at 6% of GDP, which is irresponsible in an economy that’s growing. It’s adding to stimulus.
4) Tax cuts from the Big, Beautiful Bill
Those are adding stimulus to the economy. US tax refunds are coming through now and the other stimulative parts of the bill include accelerated depreciation.
5) Lagged effects of prior rate cuts
The Fed lowered rates in the autumn and we’re going to start seeing that show up in the economy as the year continues. Obviously, the war reverses some of that but it’s adds some heat to the economy that wouldn’t be there otherwise.
6) The disinflationary tailwind from housing is ending
There are huge lags in housing inflation because of how it’s calculated but if you look at real-time house prices as a view on future housing inflation, it’s flat at the moment. That’s incrementally inflationary because it had been a drag on inflation for two years. The housing market remains in a brutal recession but it isn’t getting worse, and there are risks that it could pick up.
7) Immigration policy changes
These are another one that’s difficult for the Fed and economists to model. The US has deported many illegal immigrants that were working at cheaper wages than American citizens. Those tasks will need to be backfilled with legal workers and that’s going to cost more. In addition, the lack of flow of immigrants and illegal immigrants will also keep the jobs market tight.
8) AI capex
It’s really hard to emphasize just how much money is being thrown at AI capex. It’s the biggest private investment boom in history and it’s largely been pumped into the US economy. Much of the spending so far was into importing chips but that’s quickly going to shift to spending on data centre buildouts, chip fabs and power
