Last week we talked a bit about the inflationary pressures that were building due to Covid-related supply chain interruptions. While inflation has undeniably picked up this past year (the >4% jump this year in core inflation is the highest since the early 1990s), inflation expectations remain subdued. The bond market’s breakeven rates* are usually a good proxy for inflation expectations, and they’re currently sitting at 2.22%, just a smidge lower than the 20 year average of 2.34% (source: Bloomberg). But the well-publicized jump in energy prices around the globe, which has forced China to implement rolling power blackouts and the UK to ease visa application standards for foreign truck drivers to ensure that their gas pumps are full, will likely keep the price of core goods a bit more expensive than we’d like them to be for a bit longer.

We’re often asked whether events like this, against the backdrop of the easy money policies of global central banks over the past decade, may set the stage for the runaway inflation of the 1970s, and the record high interest rates that followed. Anyone who carried in a mortgage in the 1980s remembers these days well (but not fondly). And everyone remembers the photos of line-ups at the gas station which are being echoed today in the UK. At this point, we think the answer is an emphatic “No.” There are some similarities in present market conditions to those that caused U.S. core inflation to peak at 14% in the late 1970s, like the loose monetary policy and large government deficits of the late 1960s to fund the war in Vietnam and President Johnson’s “Great Society.” But what caused prices to shoot higher in the early 1970s was a cascade of policy errors by the Nixon Administration (such as freezing wages and prices for 90-days, cancelling the peg of the U.S. dollar to gold, and forcing the Fed to hold rates low while inflation was spiking), the lack of a formal inflation-targeting strategy by the U.S. Federal Reserve and the rise of unionization in Corporate America. None of these conditions are present today.

The Wall Street Journal put together a short video on the subject a few weeks ago, which we’ve shared below. While it won’t win any Emmy’s, it may help put your mind at ease that 20% mortgage rates shouldn’t be in our immediate future. Assuming, of course, that our policymakers have learned from the mistakes of the past.

https://www.wsj.com/video/series/in-depth-features/what-the-inflation-of-the-1970s-can-teach-us-today/760A9529-5532-4103-9B70-75C942F5F297

*Breakeven rates are the difference between treasury yields and the yields on inflation-protected securities – ie. how much “inflation” is baked into current nominal bond yields.

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