The US is poised to enter 2022 with a booming economy and a still-mutating virus. But for Washington and Wall Street, one Covid aftershock is starting to eclipse almost everything else.
Already-hot inflation is forecast to climb even further when November data comes out on Friday, to 6.8 per cent. That would be the highest rate since Ronald Reagan was president in the early 1980s – and in the lifetimes of most Americans.
Higher prices helped deliver a banner year for US business, which is posting its biggest profit margins since the 1950s. But for Joe Biden’s administration and the Federal Reserve – who did not see it coming – the sudden return of inflation, largely dormant for decades before 2021, is looking increasingly traumatic.
It is likely to drive some big changes in the coming year, as the Fed pivots towards raising interest rates and the president heads into midterm elections with slumping approval ratings.
How did it happen? Essentially, the pandemic made it harder for the world to make products and move it around. The government shored up incomes in the crisis like never before, so households remained eager to spend. And a combination of lockdowns and Covid caution meant their purchasing power was focused on consumer goods instead of services.
That is why there are long lines of cargo ships stretching off the coast of Los Angeles waiting to dock, while used-car dealers keep hiking prices and a global commodities rally leaves Americans paying more at grocery stores and fuel pumps.
A year ago, economists were forecasting 2 per cent inflation for 2021. The pandemic had depressed prices early on, and everyone expected a rebound. But Fed chairman Jerome Powell’s prediction that it would be temporary, and not very large, was widely shared.
The first hint that inflation was about to really accelerate came in February, said Omair Sharif, president of research company Inflation Insights. “Something was bubbling under the surface – and more specifically in autos.”
A pandemic-driven shortage of semiconductors was holding back production of new cars, so buyers – including rental companies, who had sold off their fleets earlier in the crisis – were pushing up the prices of old ones.
Americans had the cash. In contrast to the last recession, when fiscal austerity held back the recovery, Congress kept the stimulus flowing. On top of the $2.2 trillion rescue package in the spring of 2020, when the pandemic arrived, came another $900 billion in December 2020, then $1.9tn more in March after Mr Biden took office.
But consumers were reluctant to spend money in gyms or restaurants, say, where they might catch Covid-19 – so they bought more goods instead. Shortages of materials, and workers, were creating bottlenecks all along the supply chain. Ports got jammed. Imports kept breaking records.
“It was a demand shock,” says Aneta Markowska, chief financial economist at Jefferies. “It’s the US consumer essentially that caused this inflationary impulse, by just buying more stuff than the global economy can produce.”
With other countries recovering too, albeit less exuberantly, globalised commodities such as oil were rebounding. US pump prices are about 50 per cent higher than a year ago.
The commodity surge was not limited to energy. One of the pandemic inflation’s headline-grabbing episodes came in lumber markets, where prices jumped about 70 per cent from early March to early May – adding steam to an incipient housing boom.
When the lumber bubble burst, some – including Mr Powell – cited it as an example of how pandemic inflation could soon fade. But global food prices, after a lull in June and July, started climbing again. Helped by some bad weather around the planet, they were up 27 per cent in the 12 months through November, reflecting jumps in everything from meat and wheat to coffee and cooking oil.
Grocery chain Kroger “saw higher product cost inflation in most categories” in the third quarter, chief financial officer Gary Millerchip said on a December 2 earnings call. “We are passing along higher cost to the customer where it makes sense to do so.”
For American business, those higher costs included wage bills. Employers were struggling to increase headcount fast enough to meet soaring demand. In June, Chipotle Mexican Grill made headlines by raising prices about 4 per cent to offset pay raises. Plenty more companies would join them as the year went on.
At least in the eyes of the market, September’s CPI report was the turning point, when inflation spread well beyond a handful of hot spots. The overall rise in the index was muted – but food and shelter contributed more than half of it, with rents jumping the most in two decades.
Mr Biden’s plan had been to follow up Covid stimulus with multitrillion-dollar investments in child care and clean energy. Centrist Democrats in Congress, though, were already pointing to government spending as a driver of rising inflation – and balking at voting for more of it. The programmes were scaled back. More cuts may follow in the Senate this month.
The president’s approval ratings were on the slide, with polls suggesting voters do not like his handling of the economy and are inclined to blame him for inflation. That spells trouble for his party, which must defend thin majorities in mid-term elections next November.
Mr Biden set up a supply-chain task force to ease logjams, released petroleum reserves, and called out gasoline companies for pocketing too much profit. He is under pressure to do more – but presidents have limited powers to counter price increases.
Throughout 2021 the White House, when pressed on inflation, has deferred to the Fed – citing experts there who said it would be transitory. But in recent months, as prices surged, Fed officials faced growing resistance to that stance, and began backing away from it.
On November 30, just over a week after he was tapped by Mr Biden to serve a second term, Mr Powell finally caved. “I think the word ‘transitory’ has different meanings to different people,” he said. “It’s probably a good time to retire that word.”
A few minutes later, he made big news: Fed officials, at their next policy meeting on December 14-15, would consider accelerating the withdrawal of monetary stimulus – potentially ending their bond purchases as early as March, and opening the door to interest-rate increases by the middle of next year.
Mr Powell’s pivot came as a surprise, with market volatility surging after the arrival of the Omicron variant. Fed officials tend to downplay the idea that any one month’s worth of data – which is all they had since taper plans were laid out in early November – is enough to force a change in monetary policy.
By that point, the great inflation debate had broken out of policy circles. It was now conducted around kitchen tables, too.
Economists tend to look at so-called “core inflation”, which strips out more volatile food and energy prices. For American workers, paying a dollar more per gallon at the fuel pumps, or 20 per cent more for beef, is a more tangible measure.
In November, one in four respondents to a University of Michigan survey said inflation had lowered their living standards, double the level of six months earlier. The unaccustomed jump in living costs put the spotlight on incomes, and whether they are keeping up.
With bosses desperate to fill an unprecedented number of vacant jobs, workers are enjoying rare bargaining power. About 10,000 workers at Deere & Co went on strike for the first time since 1986, winning a 10 per cent raise plus better retirement benefits.
Across the economy, compensation rose at the fastest pace on record in the third quarter. Those at the bottom of the pay scale have benefited most – although even there, wage increases are mostly below the current rate of inflation.
While Bloomberg Economics predicts inflation close to 7 per cent for another few months, there is widespread agreement that it will come down at some point next year.
Energy markets are already signalling some relief, with oil down about 15 per cent since late October, presaging lower fuel and transport costs in 2022. Durable goods inflation is projected to slow as the pandemic recedes and households return to more normal spending patterns.
One offset to that may be housing costs. Bloomberg Economics’ David Wilcox says they could be rising at a 6 per cent to 7 per cent pace by next summer, about double the rate in the years before the pandemic.
Maybe the biggest unknown in 2022 is wages, which are already rising faster than at any point in the decade-long expansion that ended with the arrival of Covid-19.