What is runaway inflation

No going back to the 1970s

Is the US economy threatened with overheating? The bond market is concerned, DWS less. The emerging inflation rise should only be temporary, say the experts.

Fears that the US labor market may have lost momentum in February have once again proven to be false, say DWS experts. The figures published at the beginning of March were more reminiscent of what is known in America as a "blowout". Even bad weather could do little to harm the US economy. Rapid progress with vaccinations against the coronavirus should also lift the mood - and with it the willingness of consumers to spend money again. The latter should not be lacking either, because the next stimulus checks are already following from Washington.

Not everyone should like this, however. The bond market began to worry about the economy overheating. This is all the more likely if an ongoing recovery is helped with additional stimulus packages. Or, as Wall Street veteran Ed Yardeni recently put it on his blog: "More rounds of government aid programs this year are likely to trigger a boom that will cause the post-pandemic economy to overheat." The US Federal Reserve (Fed) chairman Jerome Powell himself has repeatedly reminded of the bad experiences with inflation that got out of control, for example in the 1970s.

However, the DWS Chart of the week shows that there is still a long way to go. In a model based on the Phillips curve, DWS looks at the relationship between the unemployment rate and inflation, measured by the price index for personal consumption expenditure excluding food and energy (core PCE), the Fed's preferred measure of inflation. A repetition of 1970s-style inflation rates would require the Phillips curve to move up and steepen.

Relationship between unemployment rate and inflation

Christian Scherrmann, US economist at DWS, expects inflation rates to rise in the coming months. Much of the higher year-on-year inflation figures, which in some cases could easily climb above three percent, can be explained by base effects. For example, through oil prices, which collapsed in 2020 and have since recovered strongly.

"From our point of view, however, this increase in inflation figures should only be of a temporary nature. Whether the Phillips curve is actually shifting upwards will only be known when the labor market has fully recovered," said the expert. However, perhaps 1994 offers a better analogy than the 1970s. This, too, could put the Fed in an uncomfortable position. At the time, the momentum of the recovery took the markets by surprise, leading to fears that the central bank might fall behind the curve, leading to a sell-off in the bond market.

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