People Aren’t Worried About Inflation. Really.
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Derivative markets, gold markets, and consumer surveys show a lack of significant worry about rising inflation, with expectations returning to 2018 levels.
Matt Klein, "People Aren’t Worried About Inflation. Really.," Barrons, February 21, 2021, https://www.barrons.com/articles/people-arent-worried-about-inflation-really-51613779188
People Aren’t Worried About Inflation. Really.
Could pandemic-related shortages, the Federal Reserve’s new thinking, and the Biden administration’s spending plans mean that inflation—which half of all Americans alive today have never really experienced—is finally going to come back? It’s a big question for investors and asset managers. So far, they, along with the overwhelming majority of ordinary Americans, seem to think the answer is no.
There are two basic ways to see this.
First, there are the actual prices of financial and real assets, which reflect the willingness of people with money on the line to bet on different macroeconomic outcomes, including faster inflation. Commodity and currency markets have long been the traditional places to bet on inflation, but the creation of Treasury Inflation-Protected Securities, inflation swaps, and more esoteric derivatives such as caps and floors mean that there are many markets where traders and investors can express views about the outlook for consumer prices.
The advantages of looking at these markets is that they are populated by professionals with skin in the game and they are updated in real time. From this perspective, the recent surge in the prices of oil, copper, corn, and soybeans since Biden won the election could therefore be a signal of inflationary pressures in the pipeline.
That would be a serious misinterpretation, however. Most commodities have been in a decade-long slump. Gold has done the best of the lot—and it’s still slightly lower than the all-time high hit in August 2011. The fact that things are finally starting to revert after years of massive losses isn’t a signal of imminent inflation.
For comparison, consider how investors traded gold and oil during the 1970s, when inflation really did accelerate in a significant way. After a long period of ranging between $35 and $45 an ounce, the price of gold traded in London soared to nearly $200 an ounce by then end of 1974. It fell briefly during the severe economic downturn of 1975, only to soar to an average of more than $600 an ounce from the end of 1979 through 1980. Meanwhile, the price of a barrel of West Texas Intermediate crude oil similarly went from $3.56 a barrel in 1973 to $39.50 by 1980. Today’s moves are nothing like that.
Of course, commodities are affected by idiosyncratic factors having to do with supply and demand that are separate from broader concerns about the inflation outlook. That’s why it’s also useful to look at derivative markets where traders can explicitly buy and sell protection against a wide range of inflation outcomes. Economists at the Federal Reserve Bank of Minneapolis have been calculating these “market-based probabilities” for some time—and have found that the most sophisticated investors are extremely sanguine about the risk of price increases. In fact, traders have generally been betting that inflation will be higher than the recent past for some time. The recent uptick in the median implied expectation for inflation over the next five years represents a return to the healthy levels of 2018 rather than a worrying indicator of unstable prices.
Surveys that explicitly ask people what they think is going to happen to consumer prices over the next few years tell a similar story: No one is really worried about a sustained acceleration in consumer price inflation.
Start with the University of Michigan’s Survey of Consumers, which has been regularly asking ordinary Americans what they think will happen to consumer prices over the next year since 1978 and over the next five years since 1990. While the one-year expectations can be noisy, because many people overestimate the importance of changes in gasoline prices, the average expected inflation rate over the next five years has been stable for decades—and had been trending lower. There was a slight uptick as the pandemic began and Americans began to worry about shortages, but this had already dissipated by the end of 2020.
The Federal Reserve Bank of New York has had a similar survey since 2013. While inflation expectations for the next three years have accelerated slightly, they aren’t any higher than in 2018, and are still lower than in 2013 and 2014. Moreover, the uptick is mostly being driven by a small group of people who are expecting a major acceleration in inflation—although even they aren’t as afraid as they were in 2013.
The fact that consumers aren’t worried about sudden price increases helps explain why the actual rate of inflation has been so modest. If people were worried, they would want to stock up now before things became too expensive.
Finally, consider two surveys the New York Fed runs of sophisticated market professionals: the survey of primary dealers that trade with the Fed and the survey of market participants, which includes a who’s who of the buy side. Both surveys have asked about the inflation outlook every month for years. Ordinary people might not be paying attention to the ongoing debates about the size of the budget and the potential implications for spending and prices. But the professionals are certainly keeping an eye on things, and their considered view is that inflation will be slightly slower over the next five years compared with what they had been expecting before the pandemic.
None of this is to deny the possibility of inflation accelerating in a meaningful way. But nobody seems willing to bet much on it, despite lots of ways of doing so.
Ed Comment:“Could we add this the measures haven’t been keeping? My guess is people just extrapolate from the past. My guess is that we won’t have further large increases in offshore trade (unless we outsource more brain work which is highly plausible), as we have reach the optimal amount of offshoring. Expansion of offshore trade has probably had deflationary effects or at least unconstrained capacity, which makes it hard to set off inflation. That won’t continue. When Biden opens the southern border (I still can’t believe you voted for that) it keep low-skilled workers unconstrained. Profits and wages have been rising for high-skilled workers but I think we call that GDP growth!”
Klein points out that despite skuttlebutt Mr. Market doesn't seem concerned about inflation (might be useful for speech), “…useful to look at derivative markets where traders can explicitly buy and sell protection against a wide range of inflation outcomes. Economists at the Federal Reserve Bank of Minneapolis have been calculating these “market-based probabilities” for some time—and have found that the most sophisticated investors are extremely sanguine about the risk of price increases. In fact, traders have generally been betting that inflation will be higher than the recent past for some time. The recent uptick in the median implied expectation for inflation over the next five years represents a return to the healthy levels of 2018 rather than a worrying indicator of unstable prices…None of this is to deny the possibility of inflation accelerating in a meaningful way. But nobody seems willing to bet much on it, despite lots of ways of doing so….”