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July 7, 2022

Inflation, inflation, inflation – and the 2001 recession that maybe wasn’t

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Julius Probst
Arnaud Lieugaut
Patrick Malm
Karl-Philip Nilsson
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Global inflation

We start the week with a heatmap showing the extent of the global inflation epidemic. The Harmonised Index of Consumer Prices (HICP) measures changes over time in the prices of consumer goods and services. As the chart shows, inflation is significantly above its 10-year historical average for all countries. Food, housing and utilities, furnishings, transportation, and hospitality are experiencing the highest inflation, driven by a surge in global food and energy prices. 

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US inflation expectations

In the US, inflation expectations have eased but remain significantly above target for the next two years, according to a chart we created using data from the Federal Reserve Bank of Cleveland and ICAP. It shows market expectations have shifted lower to be more in line with the Cleveland Fed’s model, even falling below its 2% target in the longer term. 

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US inflation expectations using breakeven rates

The next chart, courtesy of David Beckworth, Senior Research Fellow at Mercatus, calculates inflation breakeven rates – a market-based measure of expected inflation. It is the difference between the yield of a nominal bond and an inflation-linked bond of the same maturity.

The two-year breakeven rate (solid blue line) shows there was a huge increase in short-run inflation expectations for this year that has since eased.

Using the two-year and five-year breakeven rates, we calculated the two-year and three-year inflation expectations for the period starting two years from now. It shows that medium-term inflation expectations are close to the Fed’s 2% (PCE) target. (Subtract 40bps from the breakeven rate to adjust from CPI to PCE inflation) 

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CPI vs PCE

The difference between PCE (personal consumption expenditure) and CPI (consumer price index) has widened to a record. The spread is typically about 40bps but has since expanded to more than 200bps as CPI soars to 8.52%. CPI puts a larger weight on shelter, food and gas and is therefore a better indicator of consumer sentiment.

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GDP revisions debunk recession definition

A technical recession is often defined as two consecutive quarters of negative economic growth. However, our chart looking back at GDP revisions prior to the 2001 recession debunks that rule

We know today that the downturn lasted from March to November 2001. However, we can see in the chart below that the first Q2 GDP figure (released in July 2001) did not record any decline in economic activity. In fact, this does not appear until August 2002, after several revisions. By then, the data showed there had been three consecutive quarters of negative GDP growth before March 2001. 

That GDP data has since been revised again, and today we can see that only Q1 and Q3 2001 recorded negative growth. Perhaps we should follow the lead of the National Bureau of Economic Research instead. Rather than relying on the two-quarter rule, the NBER considers a variety of macroeconomic indicators, especially those related to the labour market, for its recession calls. 

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GDP Q2 nowcast

Now let’s look at US GDP revisions for the present day. Using our Revision History data, we created a chart on the evolution of the Q2 GDP forecast based on the Federal Reserve Bank of St Louis’s nowcast model. Unlike the Atlanta Fed nowcast, which predicts a contraction for Q2, the St Louis Fed expects relatively high growth. Given the many conflicting data points, it is still too early to call a recession.

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US financial stress

All that conflicting macroeconomic data is being reflected in US financial stress indexes. 

Conditions have clearly tightened amid rising interest rates and falling stocks and the Chicago Fed and Kansas Fed indices show an increase in stress. On the other hand, the St Louis Fed index shows an easing of conditions. What does this tell us? That it’s down to differing methodologies? Or that financial conditions are not quite as tight as they seem, given that nominal spending remains elevated.

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German inflation

The subcomponents of Germany’s inflation data are always released with a delay of several weeks. 

But there is one way to get an early estimate.

As the largest German states publish their data a few weeks before the national data is released, we can take a weighted average of state GDP numbers to obtain an early ballpark figure for the various contributors to national CPI. 

The following scatter plot shows the relationship between the actual May value of the national CPI and the forecasted June values based on state-level data. Components below the green line are expected to have a lower inflation rate in June compared to May, whereas those above the line are forecasted to be higher. See how it shows components such as transport prices soon declining, while most everything else continues to rise. 

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German inflation contributors

Now let’s look at the actual German CPI data together with estimated contributions based on state-level data. As you can see, the estimated contributions almost perfectly add up to the total aggregate CPI, meaning the tactic of using state data to get an early estimate for subcomponents can yield impressively accurate results.

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Swedish CPI

Finally, let’s look at inflation in Sweden. Our last chart compares Swedish CPI and the Riksbank’s 2% inflation target. As you can see, the central bank has continuously undershot its own target since the late 1990s, and even more so after the 2008 financial crisis. Judging from this chart alone, it seems the Riksbank has been treating 2% inflation as a ceiling rather than as an average with symmetric deviations above and below.

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