Inflation Forecast 2022: US Inflation Likely to Gradually Ease this year

Inflation Forecast 2022: US Inflation Likely to Gradually Ease this year

Inflation Forecast 2022: In May 2022, the US recorded the highest consumer price inflation rate at 8.6%, the highest since 1981. While the Biden administration is scratching its head to find a solution, the US is also worried about a recession. The US witnessed an economic slowdown in Q4 2021 and Q1 2022. In this article, we will talk about the possible reasons for the unusual rise in inflation, and its impact on the economy. Another problem in the form of recession is also linked to inflation and we will try to gauge what is the best possible way forward for the US economy.

Causes of High Inflation in the United States

While many think the causes of inflation are recent, the reality is that the story of this inflation begins from Covid 19. The US faced a financial crisis due to lockdown at the time of Covid 19, and Fed had to adopt a loose monetary policy printing some $300 B per month under President Trump and another $100 B under President Biden.

Inflation Forecast 2022: Inflation Likely to Remain at Historical High Levels
Source: Bureau of Labor Statistics
  • In the month of May, the monthly gain for inflation was 1%, which was above the forecast of 0.7% and the annual increase of 8.6% exceeded everyone’s expectations, following an 8.3% increase in April.
  • The main culprit for the inflation is energy prices which rose by 3.9% in May, and gasoline prices spiked by 4.1%. Meanwhile, food costs were up by 1.2%. Core inflation- which excludes energy and food costs rose 0.6% for the month and 6% on annual basis. So, while inflation is a measure of the rise in costs for energy, food, real estate and various other fields, the rise in costs for gasoline and energy is way above the overall rate.
  • However, not all the sectors received shocks of inflation and stand-out sectors are electronic goods and apparel which led to the slowdowns with drops of 6.5% and 9% YoY. Actually, Americans splurged in these sectors during the stay-at-home months of 2020-21, and hence the decline in prices due to not-so-great demand is understandable.
  • The key reason for the overall inflation is the Russia-Ukraine war, being in its fourth month. It has disrupted the supply chains for oil and hence leading to higher costs of crude oil. These higher rates of crude oil get poured down to various other sectors starting from gasoline, diesel, and every sector related to transportation of goods. The rates of Brent crude touched historical high levels of $135 per barrel before cooling off to $111.6

Inflation Forecast 2022: Impact of High Inflation on the US Economy

  • Increase in short-term interest rates: Inflation is never one dimensional and very high or low inflation affects each sector of the economy differently. The Fed takes measures to control inflation, by increasing short-term interest rates and through policies of quantitative tightening. In the last meeting, the Federal Reserve increased the interest rates by three-quarters of a percentage point, its largest hike since 1994. There is likely to be another three-quarter rate hike at the Fed’s next meeting scheduled on July 27th. Following that, a half basis point hike is expected in the September meeting and then four more quarter-point increases in the next four meetings. That would bring the interest rate to 3.25% by end of the year and 3.75% early next year.
  • Quantitative Tightening: The Fed will also sell Treasury and other mortgage-backed securities in order to suck the liquidity out of the market. The Fed plans to reduce the portfolio of $9 trillion in assets by $47.5 billion per month in June, July, and August and then increase it to $95 billion per month after that. The Fed will look to sell Treasury bonds rather than just letting maturing bonds
  • Spike in Treasury bond yield: Long-term rates are not affected directly when the Fed raises short-term rates, but the inflationary environment does keep them high. Analysts expect that 10-year treasury yields to peak at 3.5% within this year. The rise in long-term bond yield will also push mortgage rates and the 30-year fixed rates loans rate should be around 6.0% from 5.4% and the 15-year loans rate will rise from 4.75% to 5.25%. Corporate bond yields have also risen due to inflationary pressure, with AAA bonds yielding 4.2% and BBB bonds 5.3%.
  • Bear Sentiments in Stock Market: Hike in bond yield directly impacts, high inflation, and uncertainty on the global political front has led to the stock market falling significantly in the last six months. All indices like Nasdaq, S&P 500, and Dow Jones have fallen more than 30% in the last six months and are in bear territory. The main reason being a high bond yield moves money from the share market to the bond market as it is considered a safer investment. The market is likely to remain volatile till the inflation fears subside and bond yields reverse back to historic levels.
  • Mid-term elections in November: Mid-term elections are scheduled in the United States in November this year. Whether Joe Biden likes it or not, Democrats are headed into the election with a slowing economy and high inflation. The economy has formally entered into recession and inflation is at historic high levels, and it seems that a peak will be formed in November.

US Inflation Forecast 2022

Biden administration has understood that this inflation issue is not transitory, but it has become more dogged and especially energy and food prices. Inflation Forecast 2022 is likely to be 8.0%, dropping to 3.5% in 2023 and then 2.1% in 2024. Economic growth is expected to be 2.8% in 2022 and then drop to 2.1% in 2023.

Inflation is expected to peak by end of summer at 9%. Gasoline and crude prices are likely to remain high till the end of Russia Ukraine war. Also, prices of cars and trucks will also stay high until the semiconductor shortage ends sometime next year. But, all these factors will subside in the next year and inflation is expected to cool off 12 months down the line.

Biden Inflation or not?

The approximate source of inflation as outlined above is a combination of the Federal Reserve printing money in response to COVID, the disruption of supply chains on account of COVID, a sudden resurgence in Global demand post-COVID, and continued expansion of the Federal Budget Deficit.

Federal Budget Deficit
2016$587 Billion
2017$665 Billion
2018$779 Billion
2019$984 Billion
2020$3132 Billion
2021$2775 Billion
2022 (Estimate)$1000 Billion

Some responsibility goes to Biden for uncontrolled spending in 2021. However, much larger blame could be attributed to COVID and associated actions, the Rusian Invasion of Ukraine as well as the Fed Reserve misreading the inflation as transitional.

Conclusion- Way Forward for United States Economy

The basic concept is the demand-supply chain in economics. It is the backbone of inflation and growth. Due to Covid 19, the Fed took up monetary easing policies which led to a cash glut in the market. After restrictions were removed, demand picked up all over the economy but supply could not match due to the Russia Ukraine war.

The Fed is doing its bit to reduce the supply by monetary policies and increasing the interest rates but is unlikely to be able to do anything to smoothen the supply chain. Supply chain issues are likely to remain impacted due to the Russian invasion, COVID Lockdowns in China, and the sudden recovery of the global economy. On the other hand, the rapid slowdown in the Eurozone economy may crash inflation much faster than forecast.

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Vineet Agarwal

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