The Great Unknown: Inflation and the Economic Recalibration

A Q&A with SIFMA’s Economic Advisory Roundtable Chair and Director of Research

The SIFMA Economic Advisory Roundtable brings together Chief U.S. Economists of 27 global and regional financial institutions. Twice per year and prior to the upcoming Federal Open Market Committee (FOMC) meeting, the Roundtable publishes the results of a detailed survey that compile the median economic forecast of Roundtable members. The survey analyzes economists’ expectations for: GDP, unemployment, inflation, interest rates, and more. It also reviews expectations for policy moves at the upcoming FOMC meeting and discusses key macroeconomic topics and how these factors impact monetary policy.

The FOMC meets tomorrow, Tuesday, June 15 and Wednesday, June 16 and so, last week, the Roundtable released its U.S. Economic Survey for Mid-Year 2021. The following is a Q&A with Lindsey Piegza, Ph.D., Chief Economist for Stifel and Chair of the SIFMA Economic Advisory Roundtable and Katie Kolchin, CFA, Director of Research for SIFMA.

Note: The Survey was populated between May 17 and June 3.

Katie Kolchin: Lindsey, it’s clear that all eyes have turned to inflation. To set the stage for us to delve into that discussion, let’s first walk through the economic forecast. Where does the Roundtable see GDP and unemployment heading in 2021?

Lindsey Piegza: We know the economy is recovering – albeit unevenly and with real struggles – however, much debate remains around the new normal and when we’ll get there. The median forecast for GDP growth is 7.5% in 2021 and 3.1% in 2022 (our December Survey forecast was 3.5% for 2021). 94% of our economists expect a long-term potential GDP growth rate of over 2%, with 82% saying this is unchanged from their pre-COVID estimates.

Aside from topline growth, there’s been a big focus on the labor market and the latest jobs reports. Our Roundtable forecasts the unemployment rate to end 2021 at 5.2%, moving lower to 4.0% in 2022.

The main factors economists see as impacting economic growth include the success of the economic reopening, U.S. fiscal policy and budget, and U.S. monetary policy.

Katie: What can we tell about the consensus risks to forecasts?

Lindsey: As expected, most see inflation as the biggest risk. Other downside risks economists are looking at are a potential lingering of the pandemic and labor supply constraints. On the upside, economists are looking at the potential for additional fiscal stimulus, a faster reopening of the U.S. economy, and larger/faster consumer spending.

Katie: Okay, so now let’s turn to the big unknown: inflation.

In April, the inflation rate ticked higher on both headline and core measures. Headline CPI jumped to 4.2% and Core CPI (CPI minus food and energy) to 3.0. That’s up from 1.4% in January of this year for both. Just last week, after our Survey published, inflation data for May showed CPI at 4.9% and Core CPI at 3.8%.

Lindsey: That’s right. To illustrate this, I’d refer readers to this updated chart from our Survey results:

Thinking back to February – vaccines were starting to be rolled out to the public and we saw a glimpse into the future as vaccinated healthcare workers attended the Super Bowl, for example. We saw the first steps, the initial signs of the economy beginning to reopen as we passed the one-year anniversary of the height of the pandemic.

Katie: Now, the real question is whether inflationary pressures will prove temporary or underlying – in other words, transitory or structural. What do you think?

Lindsey: According to Federal Reserve Chairman Powell, the recent bout of price pressures including the recent surge in April/May is likely to prove “transitory.” 88% of our Roundtable economists agree with the Chairman’s assessment, calling it transitory or temporary.

But, markets haven’t fully bought into the Fed’s inflation-dismissal rhetoric. Looking at market prices (in terms of the S&P 500 index) we continue to see ongoing volatility, ebbing and flowing around inflation data releases. We look to last week’s announcement of May CPI data as an example. Markets fell ahead of the data release but then rose to new highs after the release, despite inflation data continuing to come in hot.

At Stifel, we agree with the Fed’s assessment that much of the recent backup in inflation is a result of the economy struggling to recalibrate in a post-pandemic environment which will ultimately prove temporary.  Heading to the end of 2021 and into 2022 we anticipate inflation to subside back down nearer the fed’s 2% target, however, an additional 6-12 months of heightened prices will wreak havoc on consumers along the way.

What we know for sure, is that inflation – or the future pathway of inflation – is somewhat of an unknown; a source of uncertainty that will remain the focus both for the market and policymakers for the foreseeable future.

Katie: The last time we experienced anything like this was arguably 30 or 40 years ago – a lifetime for many and something entirely new for others. For anyone who would like a refresher, SIFMA Insights took a deeper look into inflation terminology, measurement and historical trends. That report is available here.

To understand where inflation might be headed, in the Survey we talk about it across three categories: base effect, supply side and demand side.

Lindsey: That’s right. Base effect refers to the impact from different reference points in comparing data points. Last year, at the height of the pandemic, there were significant drops in prices; this year, we see the opposite. So as the lower levels from late Spring/early summer last year fall out of this year’s equation, prices will – and are – moving higher – at least in the short term.

On the supply side, we’re experiencing labor and material shortages as supply chains are challenged by stronger than anticipated demand. Many businesses in fact are having trouble finding employees for a number of reasons including lingering health concerns and childcare issues as well as enhanced unemployment benefits which in many cases are creating an incentive to remain outside of the labor force. In fact, there have been a number of reports from restaurant owners, in particular, suggesting that finding workers is a challenge delaying reopening or impeding expansion opportunities. It will take time to work through these COVID-driven bottlenecks and temporary restrictions in supply chains, however, as the economy continues to reopen and emergency measures are extinguished, the disconnect between business demand for workers and the supply of available labor is likely to dissipate.

Now the other side of the coin – the demand side, we’re seeing a strong surge in demand for everything from travel to dining out to autos. We are also beginning to experience the impact of returning to work for both currently employed people heading back to physical offices as well as the hiring or rehiring of the unemployed. Combine this with fiscal transfers of money (stimulus checks and other benefits) and we’re seeing more income and wealth drive higher consumer spending at least for now.

Katie: Thanks, Lindsey. Is there anything else you’d note?

Lindsey: Well, we’ve certainly covered a lot, but I think it’s important to add that we know the COVID downturn was unlike any other economic downturn we have seen in history and so, fittingly, the recovery is also without comparison.

Katie: Thank you, Lindsey. This is your first year as Chair of our Economic Advisory Roundtable but you’ve been a member for several. We thank you for your participation, your camaraderie and your leadership.

Dr. Lindsey Piegza, Ph.D. is the Chief Economist for Stifel Financial. She specializes in the research and analysis of economic trends and activity, world economies, financial markets, and monetary and fiscal policies.

Katie Kolchin, CFA is Director of Research for SIFMA. A global equity research analyst with a background in market infrastructure and capital markets, she leads the team performing data and analysis work for the Association and is the author of SIFMA Insights.