Inflation is coming back, according to a Producer Price Index report published by the U.S. Bureau of Labor Statistics last week.
PPI—a measure of the average change over time in the selling prices received by domestic producers for their output—increased 1.3% in January and 1.7% on a year-over-year basis.
That's a big jump from 0.8% in December and a big turnaround from last summer when PPI was hovering in negative territory.
Core PPI, which excludes food and energy from calculations, increased 2% year over year.
Debt markets have taken notice. The U.S. Treasury market has been selling off, with the 10-year Treasury bond climbing to 1.30%, double the summer of 2020 levels.
How high can inflation go from these levels? There are four scenarios.
The first scenario is 1960s-style inflation (demand-pull inflation), driven by monetary and fiscal easing, which pushes prices higher as the economy recovers from the Covid-19 pandemic.
The second scenario is early 1970s-style inflation (cost-push inflation), driven by a spike in wages, raw materials and energy prices due to supply chain bottlenecks created by the pandemic.
The third scenario is late-1970s-style inflation, a combination of demand-pull and cost-push inflation, as demand-push and cost-push factors collide, fueling a price-cost spiral, where things can get out of control.
The fourth scenario is the 1990s muted inflation, which defies Wall Street's forecasts.
Which scenario is most likely? Hard to say. On the one side, the strong retail sales reported last week, the new stimulus package underway and the rising energy and raw materials prices make a strong case for the second scenario. Thus, the spike in U.S. T-bond yields.
On the other side, the persistently high unemployment rate and low capacity utilization make a case for the muted inflation scenario. The unemployment rate is still above 6%, initial jobless claims are above 800,000 and capacity utilization at 75.60%.
These statistics mean that there's a great deal of "slack" in the economy to absorb the higher demand generated by monetary and fiscal easing and taper any price increases.
| Metric | Value |
| Unemployment Rate | 6.3% |
| Initial Jobless Claims | 861,000 |
| Capacity Utilization | 75.60% |
Source: Tradingeconomics.com as of Feb. 18, 2021.
Then there are the situations outside the U.S. where inflation is running below 1% or is even negative (deflation).
Weak overseas inflation means that the U.S. isn't running a risk of importing inflation anytime soon.
| Country | PPI | CPI | 10-year T-bond yield |
| USA | 1.7% | 1.4% | 1.29% |
| Eurozone | 0.8 | 0.90 | -0.37* |
| China | 0.3 | -0.30 | 3.34 |
| Japan | -1.6 | -1.20 | 0.10 |
*Germany
Source: Tradingeconomics.com as of Feb. 18, 2021.
While only time will tell for sure which way inflation is heading, current economic conditions at home and abroad point to a muted 1990s-style inflation—a position Federal Reserve officials seem to subscribe to, according to the Federal Open Market Committee meeting minutes released last week.
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