“[W]e have found that barring recession periods, food and energy prices almost always rise over an extended period,” LaVorgna, along with Carl J. Riccadonna, Deutsche’s senior US economist, wrote in a note to clients. “In point of fact, the last time that food and energy prices, as measured in the consumer price index, declined over any three-year period was June 1988.”
The Deutsche team also takes issue with other Fed statements, such as the belief that inflation expectations are within historical norms. They point out that the latest University of Michigan survey shows expectations the highest since August 2008.
That’s significant because the economy then was traveling in a different direction—down—than the economy now.
“Thus, in our view the probability of a further increase in longer-term inflation expectations is rising—particularly if near-term inflation expectations continue to drift higher,” the note said.
Inflation expectations, indeed, are trending higher.
Five-year breakevens—the difference between nominal Treasurys and inflation-protected notes—are near 3 percent and trending higher. That may not sound so bad now, but unless Bernanke is unable to talk down inflation, expectations are likely to get a whole lot uglier, and soon.
“While some policymakers expect recent price pressures to be transitory as a result of slack in the labor and product markets, one can observe that 1-year inflation expectations generally do not decelerate unless energy prices lead the way,” the Deutsche team wrote. “So unless oil prices dip sufficiently to unwind the recent uptrend in retail gasoline prices, inflation expectations are unlikely to retreat.”
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