Who Really Saw Inflation Coming?

But
that
is
just
one
way
to
judge
the
change
in
the
inflation
rate.
A
second
is
the
measure
traditionally
favoured
by
economists:

core
inflation.
That
calculation
ignores
the
often-transitory
shifts
in
food
and
energy
prices.
We
can
further
refine
the
analysis
by
switching
from
the
12-month
viewpoint
to
one
month.
Using
a
longer
period
smooths
the
results,
at
the
cost
of
losing
information.
When
using
rolling
periods,
changes
can
owe
either
to
the
effect
of
the
current
month’s
report
or
to
that
which
vanished
from
the
record.
Observers
cannot
know
which.

From
this
perspective,
inflation
peaked
not
last
summer,
but
spring
2021.
Since
then,
the
inflation
rate
has
bumpily
declined.
Few
noticed
the
downturn
until
recently
because
the
movement
was
masked
by
1)
the
distraction
caused
by
rising
food
and
energy
costs
and
2)
the
use
of
12-month
trend
lines.
But
the
news
has
progressively
improved
over
the
past
two
years.

Sticky
Situation

Yet
another
approach,
one
that
economists
have
grown
increasingly
fond
of,
is
the
more
restrictive
idea
o
“sticky
prices”:
minus
food,
energy,
and
shelter.
Sticky-price
items
are
only
gradually
affected
by
inflation,
a
stipulation
that
forbids
food
and
energy.
The
measure
omits
shelter
not
because
it
lacks
stickiness,
but
because
it
muddies
interpretation.
For
example,
if
rents
on
new
leases
fell
during
late
2022,
CPI
shelter
costs
would
simultaneously
be
rising,
thanks
to
the
ongoing
effect
(via
one-year
leases)
of
previous
rent
hikes.
That
is
in
fact what
happened.

Below
is
the
picture
of
monthly
inflation
when
assessed
under
those
conditions.
By
this
account,
inflation
well
and
truly
has
completed
a
round
trip.

The
Supply
Chain

None
of
these
illustrations
are
definitive,
as
the
data
can
be
variously
tortured.
Nevertheless,
it
is
hard
to
escape
the
conclusion
that
the
inflationary
spike
was
temporary.
Inflation
optimists
argued
that
the
pain
from
rising
costs
would
soon
recede,
because
its
primary
cause
was
supply
chain
pressures,
as
companies
struggled
to
meet
the
pent-up
consumer
demand
that
followed
pandemic
lockdowns.
Although
the
decline
in
prices
took
longer
than
most
anticipated,
the
evidence
would
seem
to
support
their
claim.

(I
make
that
statement
based
not
only
on
the
previous
three
charts,
each
of
which
portrays
inflation’s
retreat,
but
also
on
the
demonstrated
relationship
between
inflation
and
supply
chain
problems.)

The
Participants

Throughout
the
events,
three
parties
delivered
their
opinions
on
the
future
of
inflation:
1)
professional
economists,
2)
their
detractors,
and
3)
the
marketplace.
The
latter,
to
be
sure,
did
so
silently,
but
its
judgments
can
accurately
be
assessed
through
the
history
of
Treasury
bond
prices.

1)
The
economists. As
a
first
approximation
of
the
truth,
no
economist
foresaw
2021′s
surge
in
inflation.
For
example,
in
November
2020
the median
estimate of
2021
core
inflation
from
the
professional
forecasters
surveyed
by
the
Federal
Reserve
Bank
of
Philadelphia
was
a
minuscule
1.8%.
The
group
assigned
only
a
1%
chance
to
the
possibility
that
the
2021
rate
would
exceed
3%.

You
can’t
get
much
more
wrong
than
that.
However,
the
economists
atoned
for
their
mistake
by
adjusting
their
views
rather
than
overhauling
them.
Consequently,
they
appear
to
have
hit
the
mark
in
2023.
Entering
this
year, they
predicted that
by
the
fourth
quarter,
the
year-over-year
core
inflation
rate
would
be
a
modest
2.9%.
That
will
likely
be
very
close
to
the
actual
figure.

2)
The
detractors. When
inflation
did
arrive,
humiliating
the
economists
(some of whom,
to
their
credit,
did
issue mea culpas),
their
critics
quickly
occupied
the
higher
ground.
The
professionals
had
erred,
they
stated
(“they”
being
journalists,
politicians,
or
sceptical
investors),
because
they
failed
to
realise
that
the
old
rules
no
longer
applied.
Too
many
years
of
lax
monetary
and/or
fiscal
policy
had
poisoned
the
well.
The
Fed’s
customary
tool
of
interest-rate
hikes
would
not
quell
inflation,
at
least
not
until
they
became
ruinously
high.

While
it’s
too
early
to
dismiss
that
argument,
recent
facts
have
not
supported
it.
At
this
stage,
such
hypotheses
are
based
more
on
distrust
than
on
the
numbers.

3)
The
marketplace. Unsurprisingly,
given
that
both
represent
the
consensus
beliefs
of
investment
professionals,
the
marketplace
reflected
economists’
beliefs.
Five-year
Treasury
notes
opened
2021
paying
the
ruinously
low
yield
of
0.36%.
Within
two
months
–
two
months!
–
inflation
had
already
consumed
that
security’s
scheduled
distributions.
Its
investors
would
lose
money
in
real
terms,
bigly.

However,
although
bond
prices
subsequently
dropped,
the
bond
market
ultimately
kept
its
faith.
Across
the
yield
curve,
Treasury
note/bond
yields
have
usually
hovered
near
4%.
If
investors
in
sum
thought
that
high
inflation
was
here
to
stay,
they
would
have
demanded
a
significantly
higher
rate.

Missing
the
Turn

Institutional
investors
benefit
from
solidity.
Their
decisions
are
anchored
in
data,
and
(both
because
their
views
are
collective,
and
because
their
motives
are
profits)
reasonably
free
of
personal
bias.
Over
the
past
year,
their
relative
immobility
has
served
them
well,
as
adjusting
their
previous
beliefs
more
accurately
forecast
what
transpired
than
overhauling
them
would
have
done.

Unfortunately,
professional
investors
usually
miss
turning
points.
The
recent
inflation
surge
proved
no
exception.
When
storms
arrive,
economists
and
the
marketplace
typically
react
only
after
the
fact.

In
contrast,
those
outside
the
investment
mainstream
habitually
look
forward,
alleging
that
this
time
is
in
fact
different.
In
2021,
that
claim
was
spectacularly
correct,
permitting
them
to
spot
what
the
professionals
overlooked.
But
most
skeptics
oversold
their
argument,
by
suggesting
that
because
the
economists
once
blundered,
they
would
do
so
again.
That
does
not
appear
to
be
the
case.

This
episode
illustrates
once
again
the
difficulty
of
mingling
economics
and
investing.
Who
to
trust?
The
insiders
were
wrong,
and
then
they
were
right.
Their
detractors
were
right
and
then
wrong.
Few
investors
could
have
timed
that
call
correctly.

The
views
expressed
here
are
the
author’s.

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