The U.S. is poised to enter Year Three of the pandemic with both 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%. 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 U.S. business, which is posting its fattest profit margins since the 1950s. But for Joe Biden's administration and Jerome Powell's Federal Reserve -– which didn't see it coming — the sudden return of inflation, largely dormant for decades before 2021, is looking increasingly traumatic.
It's likely to drive some big changes in the coming year, as the Fed pivots toward 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 produce stuff 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's 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 gas pumps.
Hotspots to Everywhere
A year ago, economists were forecasting 2% inflation for 2021. The pandemic had depressed prices early on, and everyone expected a rebound. But Fed Chair 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 LLC. "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 firms, who'd sold off their fleets earlier in the crisis — were bidding 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 $1.9 trillion more in March after Biden took office.
But consumers remained 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 U.S. consumer essentially that caused this inflationary impulse, by just buying more stuff than the global economy can produce."
Commodity Stories
With other countries recovering too, albeit less exuberantly, globalized commodities like oil were rebounding. U.S. pump prices are about 50% higher than a year ago.
The commodity surge wasn't limited to energy. One of the pandemic inflation's headline-grabbing episodes came in lumber markets, where prices jumped about 70% from early March to early May –- adding steam to an incipient housing boom.
When the lumber bubble burst, some — including 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% in the 12 months through November, reflecting jumps in everything from meat and wheat to coffee and cooking oil.
Grocery chain Kroger Co. "saw higher product cost inflation in most categories" in the third quarter, Chief Financial Officer Gary Millerchip said on a Dec. 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 Inc. made headlines by hiking prices some 4% 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 hotspots. 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.
