The latest data suggests US inflation has yet to peak. There have been claims from time to time that the peak had come and gone but many people (including the Federal Reserve) were caught out time and again by the data.
The standard exercise for determining if inflation has peaked is to chart broad money supply, M2, and CPI growth rates with the lead-lag relationship as shown in chart one.
Although the former predicts the latter, the correlation is never high, as can be seen from the loose comovement between the two series. In other words, even if inflation is expected to peak now and come down by year-end, the timing is highly uncertain.
Another way to project it is based on the persistent behavior of inflation.
By matching the same past inflation series with the present one with reference to the 1970s experience, regarded as history repeating itself, inflation is expected to peak in October and decline afterward.
Nevertheless, whether based on M2 as in chart one or historical developments as in chart two, inflation will not come down meaningfully by year-end.
If history repeats itself, inflation will still be above 6 percent by mid-2023 and will fall below 4 percent only by end-2023. This has important implication for the funds rate.
Even based on an optimistic scenario with an earlier peak (chart one), inflation will not go below 4 percent in 12 months.
If the Federal Reserve dares not pause with inflation above 5 percent, the rate hike cycle will need to be extended at least until the first, or even the third, quarter of 2023.
This is longer than most people expect as it means there will be five to eight more meetings that require rate hike decisions.
Even counting the gradual slower hiking speed, there will be a conservative 3 to 4 percent more to go. Adding this to the existing mid range of 2.375 percent, that will end up with us facing 5 to 6 percent.
This is certainly not too high by historical standards, but it is the high speed of hikes crashing into sky-high asset prices that is worrying. And that unwelcome scenario is indeed playing out in reality now.
Law Ka-chung has worked in the financial industry and the government for two decades. Reach him at mewe.com/join/lawkachung, facebook.com/kc.economist, lawkachung@gmail.com
