The curious case of US inflation.


Inflation and jobs are key economic measures.

Inflationary expectations and employment are key drivers for US monetary policy.

Monetary moves by the US Federal Reserve’s open market committee (FOMC) effect the USD, and in turn the number of Aussie dollars received by WA commodity exporters when they convert their USD export sales.

So, it’s always good to keep an eye on what FOMC is up to.

Jerome Powell’s message.

Recently, Fed Chair Powell indicated that FOMC still likes a December interest rate hike.

He has even spoken about potentially faster growth to be had, which I guess allows him to continue stoking the flames for more hikes next year.

Donald Trump, Jim Cramer and many others think there’s something not quite right about raising interest rates now and they blame Powell for the current equities rout.

That’s all well and good, but what’s of interest to me is the still low level of inflation (2.5% in October) relative to historic prints, especially given bulging US employment metrics.

Unemployment in the US has not seen these lows since the 1960s, and more people working and spending should mean higher prices. That’s what the Phillips Curve says, surely that’s elementary?

Yes, that’s what the Curve says, but currently the Curve is so laid back it’s almost flat - the relationship between unemployment and prices no longer appears to be inverse.

The following chart from Powell’s recent Senate testimony, courtesy of a recent and interesting Forbes article, demonstrates the rather curious case of missing inflation (relative to the past).

Forbes, Federal Reserve presentation materials.

Forbes, Federal Reserve presentation materials.

The Amazon Effect and its curious effect on inflation.

There is a current school of intrepid thought suggesting that Amazon and similar on-line sellers have taken a tonne of margin out of retail.

This margin decline is a result of being able to influence shopping pricing behaviour to a greater extent and quicker (i.e., immediately) than was possible prior to cloud delivered market places and on-line retailing.

  • Bricks and mortar retailer: Offers a fixed range of goods and services at traditional cost++ prices. Prior to the cloud, altered prices less frequently, not very customer-centric.

  • Amazon: Offers biggest range of products at low prices and offers the Amazon Prime experience, where for $150 a year you receive access lowest cost goods with free 2 day and even 2 hour deliver delivery options, plus significant benefits across the Amazon business (e.g., unlimited video streaming, Whole Foods discounts, etc.). Focus is on customer. Happy to sacrifice profits (so far).

  • Competitive response to Amazon: Physical and on-line retailers drop their prices to compete and/or introduce home delivery options.

  • Effect on consumer and Inflation: Consumer gets cheaper goods and services and is economically happier. But, inflationary effect potentially hidden in lower consumer prices (other than oil/energy) and perhaps better detected by removing the Amazon Effect in prices, or moving to output based.

Here’s a refresher on the work so far done by Cavallo on the Amazon Effect, presented at this year’s Jackson Hole economic symposium.

Volatility of Output, not just price.

In commenting on Cavallo’s work in this area, Gorodnichenko suggested placing a higher weight on volatility of output, as opposed to prices.

As I have previously mentioned, if you adopt this view it probably goes some way to explaining the low inflation prints, and to solving the conundrum presented in the chart.

This might also suggest that low inflation in the post-Amazon era should not be a key reason to keep interest rates low.

But what happens when the cheap and easy money is finally gone, and on-line retailers/market places come under debt and margin stress - do prices go back up? Will that be the potential slingshot moment for inflation?


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