Rosenberg Sees Inflation After Calling Housing Bust in RecessionShobhana Chandra and Steve Matthews
Prices in the U.S. may increase more than many expect this year, says David Rosenberg. That’s a 180-degree turn for the economist who not long ago correctly predicted a declining inflation rate, a view now prevalent among his peers.
“This deflation, disinflation, benign inflation story which seems to be everybody’s mindset is really yesterday’s story,” said Rosenberg, 53, chief economist and strategist at Gluskin Sheff & Associates in Toronto. The Federal Reserve, through efforts to spur growth, “is carrying out the mother of all reflationary policies,” he said in an interview. “My bet is the Fed will ultimately get what it wants, and then some.”
Such a scenario is out of sync with the consensus. Janet Yellen, the new chair of the Fed, has said inflation is running below policy makers’ 2 percent target and is unlikely to flare up soon. The median forecast in a Bloomberg survey of economists in January put inflation at 1.3 percent in 2014 and 1.8 percent next year.
Investors, too, are sanguine: The five-year breakeven rate, a market gauge of inflation expectations over the next five years based on trading in inflation-linked Treasuries, was at 1.92 percent yesterday, down from 2.32 percent last year at this time.
Rosenberg predicts wages and rents will head higher as the job and housing markets rebound, and as faster credit creation and record stimulus by the Fed stoke price pressures. He said it’s troubling that “whether you’re bullish or bearish on the economy, the one universally held view right now is that there is no inflation whatsoever.”
Known for his pessimistic outlook on the U.S. economy, the former Merrill Lynch chief economist for North America was among the earliest to warn of the housing bubble in 2005 and the recession that began in 2007, though he missed projecting the stock market’s rally since 2009, which enabled the Standard & Poor’s 500 Index to appreciate about 170 percent.
Rosenberg, who raised concern about impending disinflation in late 2006, changed his call last year, saying bonds were no longer a safe bet as growth was picking up and inflation was in the cards. Treasuries returned 1.6 percent in January, the best start to a year since 2008, according to the Bank of America Merrill Lynch U.S. Treasury index.
Complacency over prices is reminiscent of 2003, when few economists and policy makers foresaw the bout of inflation that caused the Fed to begin raising interest rates in June 2004 and continue for two years, Rosenberg said. He predicts a spurt in prices this year will prompt investors, who now expect interest rates to hold close to zero until the second half of 2015, to change tack.
Rosenberg said this week he is sticking to his view even as the Fed’s preferred price gauge, tied to personal consumption, showed prices climbed just 1.1 percent in the 12 months through December.
“You have to expect that as the economy does better inflationary pressures follow suit,” Rosenberg said. “The Fed will purposely lag the cycle, which is why the yield curve has been steepening and will continue to steepen. But at some point the bond market will call the Fed’s bluff and the Fed will have to start raising interest rates.”
The Federal Open Market Committee, which cut the target interest rate to near zero in December 2008, last month reiterated its commitment to keep borrowing costs low.
It “likely will be appropriate” to hold the target rate near zero “well past the time that the unemployment rate declines below 6.5 percent, especially if projected inflation continues to run below the committee’s 2 percent longer-run goal,” the Fed said in a statement after the January meeting, while deciding to trim monthly bond purchases to $65 billion from $75 billion. Unemployment in January stood at 6.6 percent.
The FOMC projects the personal consumption expenditures price index will rise 1.4 percent to 1.6 percent this year, accelerating to 1.7 percent to 2 percent in 2016. The gauge hasn’t exceeded the Fed’s goal since March 2012. A different measure, the consumer-price index, rose 1.5 percent last year, the smallest calendar-year gain since 2010, the Labor Department reported on Jan. 16.
The figures counter “those who’ve been saying, you know, for the last five years that we’re just on the brink of hyperinflation,” former Fed Chairman Ben S. Bernanke said the day of the CPI report at a forum sponsored by the Brookings Institution in Washington. The Fed has “all the tools we need” to ensure inflation doesn’t surge over the next few years even if it maintains a large balance sheet, he said.
Testifying before Congress this week, Yellen reiterated that “inflation remains below our longer-run objective.” Some of the recent softness “reflects factors that seem likely to prove transitory, including falling prices for crude oil and declines in non-oil import prices,” and inflation is likely to move back toward 2 percent “over the coming years,” she said.
At Bernanke’s request, Yellen as Fed vice chair led efforts to adopt a statement of the FOMC’s longer-run objectives, including a target for inflation. The statement “has helped anchor the public’s expectations that inflation will remain low and stable in the future,” she said at a Nov. 14 hearing.
Yellen should know about inflation expectations. Her forecasting record was the best out of 14 Fed policy makers, the Wall Street Journal reported last July based on its analysis covering the period from 2009 to 2012.
The signals from the bond market currently suggest no imminent surge in price pressures, Federal Reserve Bank of Chicago President Charles Evans said Jan. 15 in Coralville, Iowa. In fact, the Treasury yield curve “provides convincing evidence that inflation is low,” he said.
The Fed is “vigilantly on the lookout” for inflation, he said. Addressing the possibility of a “recurrence of a 1970s-style wage-price spiral,” Evans said the current situation is “much different from the circumstances we found ourselves in back then.”
Rosenberg isn’t reassured: “Once the genie is out of the bottle, it is very difficult to control.”
Some support for his view comes from former Federal Reserve Bank of Cleveland President Lee Hoskins, who says the bias of Fed policy makers “is towards more inflation.” The FOMC “will not react quickly to rising inflation. The Fed balance sheet is going to be tough to unwind.”
Rosenberg addressed that risk in a Dec. 16 note. “I see all the signs ahead of cost-push inflation -- which will become more readily apparent once commodity prices find a bottom,” he wrote. “The next decade is going to look more like the 70s than many think.”
Triggered by the oil shock, inflation surged to almost 12 percent in 1974. The Fed under Chairman Arthur Burns was slow to respond and forecasters and bond investors were also caught off guard. Paul Volcker, who took over as the central bank chief in 1979, had to raise the federal funds rate in the following year to as high as 20 percent.
In an interview in January, Rosenberg said the U.S. may avoid double-digit inflation because of “structural and demographic factors that will limit how far inflation is going to go.” Still, it may “revisit the highs of the last cycle” marked by close to 5 percent for the CPI and 3 percent for the core index, he said.
Inflation is a lagging indicator and will respond as wages, rents and the so-called velocity of money -- a gauge of how quickly money changes hands in the economy -- are “going to be rising significantly over the course of the next several quarters,” Rosenberg said.
Allan Meltzer, a professor of political economy at Carnegie Mellon University’s Tepper School of Business in Pittsburgh and the author of a history of the Fed, said it’s possible inflation could heat up, but not for the reasons Rosenberg offers.
“Cost-push inflation is bad economics,” Meltzer said, arguing inflation is mainly a monetary phenomenon driven by money and credit growth, not by rising labor and raw materials expenses. Still, he said, “inflation seems likely to rise” because the Fed has in the past been slow to respond.
Rising wage pressures and a drop in the rental vacancy rate signal core inflation is about to turn the corner, said Torsten Slok, the New York-based chief international economist for Deutsche Bank AG. Average hourly earnings for private workers show that once wage inflation takes hold, it continues for several years, he said, citing a four-year surge that began in March 2004 and a five-year spurt from early 1994.
While the U.S. is still “in the early phase of this uptrend, inflation will be grinding higher by the end of this year,” Slok said. “The risk is, the market could start to worry about inflation before the Fed does.”
The concern echoes that of Rosenberg. He said he’s betting that in time, his contrarian stance will prove less “ludicrous” than it seems now.
“Leave it to the Fed to overemphasize inflation risks at the peak in the interest-rate cycle and leave it to the Fed to underestimate inflationary pressures at the bottom of the interest-rate cycle,” Rosenberg said. Going against the Fed’s focus, he said, is his “time-worn metric for success in the investment landscape.”