Why did used car prices go up 50% during the pandemic, was it because of more demand for vehicles, or was it because of supply chain problems with semiconductors? The answer to this question will determine where the Fed funds rate will peak during this cycle.
Specifically, identifying the sources of the increase in inflation is essential for understanding how quickly inflation will return to the Fed’s 2% target. A recent Fed working paper suggested that only 1/3 of the inflation increase during the pandemic was due to demand. If that is the case, the Fed today will not need to destroy much demand, and inflation will automatically come down to 2% again.
With supply chains improving every day and growth slowing, the trend in inflation should be lower. If supply problems mainly drove the run-up in inflation, then inflation could come back to 2% faster than the market currently thinks. In that case, a soft landing is likely, and equities and credit should be trading higher.
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