In an alternate universe, America clearly passed its peak in inflation a couple of months ago; the Federal Reserve is still talking tough but investors have started to expect less monetary tightening, a great relief for stockmarkets; and Joe Biden can at last sense victory over rising prices, arguably the greatest nemesis of his presidency thus far. Until a few days ago many thought America would be inhabiting that other world. Alas, a brutal batch of data has awoken them to a more dispiriting reality. Inflation, far from peaking, seems to be gaining altitude, with potentially dramatic consequences for the Fed, for investors and for American politics.
On June 10th the Bureau of Labour Statistics reported that the consumer-price index in May was 8.6% higher than a year earlier, the fastest annual rate of inflation since 1981. More concerning was the momentum. Month on month, consumer prices rose by 1%, well above the 0.3% increase in April.
Adding to the grim news was a plunge in consumer sentiment to a record low, as measured by a closely watched survey from the University of Michigan. The principal cause was stubbornly high inflation. Consumers now expect an average inflation rate of 3.3% over the next five to ten years, up from their expectation of just 3% a month earlier. This does not yet mean that inflation expectations are “unanchored”—a much-dreaded condition that could set the stage for an upward spiral in prices—but it certainly is enough to stir fear at the Fed. The broadening of inflationary pressures, from goods such as cars and electronics to wages and rental costs, darkens the backdrop. And motorists will have noticed the surging price of petrol, which, for the first time ever, now exceeds $5 a gallon.
Had America been in the more benign alternate universe, talk now would have centred on when the Fed might be able to adopt a more relaxed posture. Indeed, as recently as May 23rd, Raphael Bostic, president of the Fed’s branch in Atlanta, said the central bank may want to pause its interest-rate increases at its meeting in September, in order to take stock of all the latest developments.
Such restraint now seems off the table. Instead, bond pricing has shifted in a far more hawkish direction. It is a foregone conclusion for most investors that the Fed will raise rates by half a percentage point on June 15th, for the second straight meeting. Beyond that, some are now betting on three-quarter-point increases at meetings in July and September. The last time the Fed delivered such a jumbo rate rise was in 1994 under Alan Greenspan.
The prospect of the central bank slamming on the monetary brakes has unnerved markets. The S&P 500, Wall Street’s flagship stock index, has tumbled by 5% since the inflation data were released. Tech stocks, from Amazon to Tesla, have sold off even more sharply. And for some high-risk assets, the carnage has been far worse. The price of Bitcoin fell by more than 10% on June 13th after Celsius, a cryptocurrency lending firm, paused all withdrawals from its platform because of “extreme market conditions”. The historical record suggests that America would be lucky to escape a recession when the Fed tightens so aggressively.
For Mr Biden’s administration, the economic frustrations are only deepening. On one hand, inflation is much more than just an American problem. In Britain, consumer prices have been rising even faster, hitting an annual pace of 9% in April. From Germany to Australia, inflationary pressures are bubbling up. Even Japan, long mired in deflation, is not immune. The rapid ascent in food and energy prices, caused in large part by Russia’s invasion of Ukraine, is a global affliction. Continuing snags in cross-border supply chains, stemming from the covid-19 pandemic, have made matters worse. Mark Zandi, an economist with Moody’s Analytics, an arm of a credit-rating agency, estimates that Russia’s war and the lingering covid pandemic account for nearly two-thirds of the annual rise in inflation over the past year.
On the other hand, American voters will not be so forensic in their analysis of price trends, nor so forgiving in their assessment of Mr Biden’s responsibility. Just over 500 days into his presidency, 53.6% of Americans disapprove of his performance, while 39.7% approve, according to calculations based on polls by FiveThirtyEight, an analysis website. That negative gap of 13.9 percentage points is the worst at this point in the electoral cycle for any president since at least the second world war.
Mid-term elections, due to be held in November, rarely go well for the president’s party. Sky-high inflation could make them an unmitigated disaster for Democrats, with Republicans on track to wrest control from them of both the Senate and the House of Representatives. Mr Biden has tried to direct attention to the millions of jobs recovered over the past year as America claws its way back from the pandemic. But the soaring cost of living and the rising prospect of recession are instead top of mind. ■