U.S. inflation reached 9.1% in June: and now what?

This Wednesday, the U.S. Bureau of Labor Statistics released the CPI report for the month of June. According to the authorities’ data, U.S. inflation hit another 40-year high at 9.1%.

This number was considerably higher than the 8.8% estimate predicted by Dow Jones economic analysts. Also, compared to the previous month’s (May) number, the increase was a difference of 50 basis points.

It should be remembered that last month the announcement of the 8.6% CPI generated an earthquake in the financial markets. Consequently, on June 13 all assets collapsed, including cryptocurrencies. This showed how close recession could be in that nation’s economy.

Reaction to U.S. inflation

The U.S. economy suffered a new onslaught of inflation during the month of June. This was led by fuel and food prices. The weight of this situation is mainly manifested in household budgets.

The winding road could be far from coming to an end. This is because the conditions that have led to price growth remain intact in terms of momentum. Tight oil supply, supply chain disruptions and the war in Ukraine look to be weighing most heavily.

If these three components continue to lurk, as all indications suggest, prices are unlikely to retreat in the domestic market. Covid-19 in China continues to affect the trading capacity of that country and its partners. Meanwhile, the war in Ukraine seems to drag on interminably with all the negative outcomes that implies. EU countries seem to be trapped by the backlash of sanctions against Russia.

In any case, US inflation seems to be more stimulated despite the rate hikes. It should be recalled that the last rate move by the Federal Open Market Committee (FOMC) was 75 basis points in June. The results of that move appear not to be as expected and the same could be heading down another lane, that of recession. Beyond inflation, what the market fears most is the Fed’s reaction to it.

The pace of inflation in the U.S. economy

The problem with the high CPI is that the Fed has been announcing that it will do whatever it takes to bring it down. However, the toolkit that the central bank has at hand is not so broad, but rather it is certainly reduced. Practically, the only monetary measure now is to raise the interest rate to such an extent that the economy freezes.

The rate hike consists of making credit prices more expensive, so that companies slow down the pace of applications. The chain that follows is long and involves an explosion of layoffs, falling wages and a slump in retail consumption. Companies’ profit margins fall and their stock market shares plummet. As a result, prices begin to fall at the cost of household pain.

Consequently, defeating inflation in the U.S. economy becomes a dilemma for financial policymakers. As the CPI reaches current limits, the Fed becomes more aggressive, as moderate rate hikes would not be enough to cool the economy. For example, in April inflation fell back from 8.5% in March to 8.3%. The first rate hike seemed to have achieved the objective of curbing inflation.

However, the 8.6% in May shattered those assumptions and the Fed implemented a more aggressive rate hike of 75 basis points. As the highest increase since 1994, inflation was expected to come down, but fuel prices hit hard. Similarly, the unemployment report was even more shocking with new payrolls coming in well above expectations.

With the current CPI up to 9.1%, plus the employment report, it seems clear that the rate hike did not take effect.

Fed comes in with the force of hawks

Considering that a 75 basis point rate hike fell short, expect the next hike to be higher. The next FOMC meeting is scheduled for the end of this month. It will decide on a further rate hike, which was expected to be between 50 and 75 basis points. However, some analysts fear it could be a full percentage point.

“The Fed could be faced with the need to make an interest rate hike similar to the one made by Paul Volcker 40 years ago.”

The Fed needs three things now: for unemployment to rise, for financial markets to extend losses, and for people to stop spending. In other words, it needs to sink the economy, but of these, only the markets seem to be having a bad time.In other words, dominating employment and retail consumption could mean increasing the beating on stocks, especially growth stocks.

If this does not bring down inflation in the U.S. economy, two scenarios could emerge and policymakers would have to choose one. The first is a long period of stagflation (slow economic growth accompanied by inflation). The second option would be to resort to a radical measure comparable to the one Paul Volcker took 40 years ago.

By that time, inflation was wrecking the economy and Fed Chairman Volcker implemented a 20% interest rate hike. With that violent hike, inflation finally came down, but it took not one, but two recessions to bring the economy down.

A troubling difference

But today’s times contrast with Volcker’s in much more than a chronological difference. The 1980 rate hike succeeded in lowering inflation because output shortfalls were covered by imports from China. By then, products from that Asian country were flooding Western markets unhindered.

It should be noted that at that stage of the Cold War, geopolitics reached limits that today might seem incomprehensible. Communist Party China allied with the U.S. to confront the common enemy: the Soviet Union, when both communist countries were supposed to be allies. As a result of that strange combination, Washington removed any barriers to the Asian country’s products entering its commercial ports. In the long run, this contributed to lower U.S. inflation.

Currently, the issue is diametrically opposed, given the trade war, initiated during the Trump administration, is present. The absence of Chinese goods could lengthen the suffering of U.S. households. Therefore, some specialists consider that the elimination of tariffs on Chinese goods could cool the economy now.

“The main problem in the U.S. today is the hollowing out of industries and the inefficiency of the sector and supply chains,” explains Peng Bo, a specialist in international economic issues. He further notes that if the U.S. “removes all tariffs on Chinese goods, inflation is likely to decline by as much as 1.3 percentage points.”

Is inflation reaching a peak or is this a mirage?

Analysts are divided on how close the inflation peak is. Some claim that such a situation is coming, while others believe that prices will cool down over a long period of time. At the moment, both arguments seem logical, but, at the same time, they leave some room for question marks.

For example, unlike in June, oil prices have fallen sharply so far this month. This indicates that the price of fuel, one of the main drivers of inflation in the U.S. economy, will have less impact on the CPI. Thus, it could be taken for granted that inflationary pressure will ease in the next report, not because of the rate hike, but because of the drop in oil prices.

At the forefront of this equation is the other indicator, core inflation. This excludes the prices of energy, fuel, food and other highly volatile products. If inflation were at a peak, the core index would go down. However, in June core inflation also rose above the 5.7% estimated by Dow Jones and stood at 5.9%. This brings it back close to the 6.5% peak of March.

The issue with this inflation is that it is structural and the fact that it is rising could indicate a prolonged upward trend in prices. In the midst of this context is the current economic situation. Analysts believe that the slightest miscalculation by the central bank could unleash major problems.

Some numbers behind the rise in the CPI

The new 40-year record rise in inflation was driven by well-known geopolitical factors, which show no sign of easing, Navy Federal Credit Union’s Robert Frick explains to CNBC. At the same time, these directly influenced domestic prices. Of these, the most pronounced were energy, which rose 7.5% in June and 41.5% on a 12-month basis.

The food index rose 1%, but the largest contribution to the CPI increase was due to the increase in fuel. As a result, gasoline rose 11.2% during the month and on a 12-month basis was just under 60%. Electricity rose 1.7% and 13.7% in the same order and new and used cars 0.6% and 1.7% respectively.

As for the cost of medical care, the rise was 0.7% and 1.9%. The aforementioned portal says that U.S. inflation is generalized and is not limited to certain products or services.

For workers, the situation was also deteriorating, with a 1% decrease in real wages. This is calculated on the average hourly income. In annual terms, this same income has suffered a 3.6% drop. It should be remembered that a fall in real wages means a lower capacity to purchase inputs with the wage, regardless of whether the wage has increased nominally. In other words, input prices rise at a faster rate than wage increases. Thus, although a worker earns more, his purchasing power is less.

Inflation is the government’s priority

After the June report was released, U.S. President Joe Biden said that inflation was a priority for his administration. He also ratified his call for refineries to process more fuel to help lower gasoline prices. As already noted, this was one of the main drivers of CPI as it reached record prices in June, averaging over $5 dollars per gallon.

The President of the United States has placed the responsibility for inflation on several actors. One of them is the war in Ukraine, which is a major driver of food and commodity prices. Last month, Biden claimed that US inflation was “Putin’s tax” on US citizens.

While the role of the war in Eastern Europe is of great importance, it should be kept in mind that U.S. inflation did not begin in February. In fact, months before the outbreak of hostilities in Ukraine, the U.S. economy was already dragging serious price problems. In December, two months before the war, Fed Chairman Jerome Powell stopped referring to inflation as a “transitory” issue.

Even earlier, in November, the FOMC agreed on the approximate dates for the start of the lifting of emergency measures. These are the rate hike and the phasing out of debt purchases.