Jerome Powell and Janet Yellen aren’t worried about inflation. Maybe they should be

Federal Reserve chair Jerome Powell and his predecessor Janet Yellen, now the first woman to serve as Treasury secretary, are both known for their dovish stances on inflation. That suggests they are unlikely to be in any particular hurry to push for higher interest rates.

And with the economy still struggling due to Covid-19, neither Powell nor Yellen seems overly worried that the unprecedented amount of stimulus from both the central bank and Congress will spark any persistent inflationary pressures just yet.

But should they be?

Powell said in a Princeton talk last week that there could be “quite exuberant spending” from consumers over the next few months thanks to stimulus checks and an improving economy following broader access to vaccines. Some prices could rise as a result.

But the Fed chair argued this may not necessarily be inflationary for the long haul. Price increases could be — to use a favorite Fed buzzword — transitory.

Yellen similarly noted in her Senate confirmation hearing last week that she believes the Fed and the Biden administration should take advantage of interest rates being near zero and thus spend more on stimulus.

In other words, now is not the time to fret over inflation.

“Inflation is always a concern and it’s an easy concept to grasp,” said Mimi Song, chief economist at CrossBorder Solutions. “Lower supplies could lead to higher prices for the short-term and more stimulus could lead to higher disposable income.”

But Song contends the global pandemic and recession will likely keep a lid on prices. The priority needs to be the economic recovery, not the fear of inflation several years from now.

Inflation could come roaring back

Still, some worry that Powell and Yellen are being too dismissive. The economy may not be able to remain in a scenario where inflation pressure simmers without boiling over.

The 10-year Treasury yield is now back above 1% — its highest level since March. Oil prices are up 10% in the past month as well. These are signs that investors are betting on more inflation sooner rather than later.

“There is this tug of war around inflation,” said Todd Lowenstein, equity strategy executive of The Private Bank at Union Bank. “Inflation could be transitory but we need to keep an eye on the bond market due to massive federal spending.”

Lowenstein said stimulus spending, while necessary, could lead to further declines in the value of the dollar, which would fan the flames of inflation. But the Fed is not in a position to raise rates to stem inflation while the economy is still so fragile. Inflation could become more of a consistent problem.

“Could inflation become entrenched? The Fed doesn’t want to fight it right now, but historically the issue is that inflation is like toothpaste in a tube. It’s impossible to put back,” Lowenstein said.

If inflation pressure does mount, the Fed can’t ignore it indefinitely — at some point, it has to fight it off.

And that is key. The Fed has tried to remain out of politics and do what it deems best for the economy, no matter what actions the president and Congress decide to take.

“The Fed risks losing the perception of its independence if it doesn’t fight inflation,” said Adam Lampe, the CEO and Co-founder of Mint Wealth Management.

“An unexpected rise in inflation could be a risk,” he added. “Inflation should be modest in 2021, but once it’s let out of the bag it could come back quickly.”

Keep an eye on wages and the job market

So the Fed may be forced to raise rates sooner than the market is currently expecting, or it may need to more rapidly cut back on — or taper — its current program of bond purchases. The last time the Fed made a significant change to its asset purchases, in June 2013, stocks sold off rapidly in what came to be known as the “taper tantrum.”

Still, the biggest driver of inflation tends to be a healthy job market and bigger paychecks for workers. That’s not the case right now.

According to the December jobs report, average hourly wages grew about 5% from a year ago. But the government noted those increases “largely reflect the disproportionate number of lower-paid workers in leisure and hospitality who went off payrolls.”

In other words, wage growth would have been a lot lower if more Americans were actually working.

Other government data shows that there are only small pockets of inflation.

According to the latest consumer price index report, food prices rose 3.9%. Appliance prices shot up 6.2% and used car prices surged 10%. But overall, consumer prices gained just 1.4% over the past year.

“If you look at the stock market and industries like housing, you might feel like the economy is back on its feet. But there is still enough slack in the job market to prevent any short-term inflation,” said Craig Fehr, investment strategist at Edward Jones. “I don’t think inflation will be a predominant risk.”

Yet Fehr is concerned that inflation inevitably will become a major issue that policymakers must tackle.

“Longer-term, the risks of inflation cannot be overstated. The market is expecting incredible levels of Fed stimulus for an extended period of time,” he said. “If you ask me what usually keeps me up at night, it’s inflation.”