September 11, 2023 | 2 MIN READ

Weekly Market Update

Why US Inflation Is Unlikely to be Like the 1970s

What happened last week?

  • The S&P 500 lost 1.29%
  • The Dow Jones declined 0.75%
  • The Nasdaq shed 1.93%

When it comes to economic history, many have sought to describe where we are now as a 70s throwback. The inflation of the 70s was mighty, mighty, but is the present déjà vu more than a feeling?

In 2021 and 2022, we have suffered inflation averaging nearly 7% in the US and higher in some regions. In the 1970s inflation ran at 8% for 10 years.

So, are we entering a period like the 70s or are we exiting a period of unusual, non-systemic dislocations?

With current bond yields roughly half of their upwardly-trending 1970s levels, should we be worried?

We do not see a return to sustained 1970’s-style entrenched and accelerating inflation. Our reasons include large monetary policy differences, major shifts in global dynamics and the rise of information for consumers as a contributor to more competitive pricing.

3 Things to Know

A New Normal for Interest Rates

We believe the widespread fear that we are in a repeat of the 1970s period of rising inflation and eroding asset prices is misplaced.

Notably, such fear is not priced into markets. US Treasury Inflation Protected Securities embed a 10-year average 2.3% gain for the Consumer Price Index.

Meanwhile, the S&P 500 trades at 20X this year’s likely profit. Even as we still expect yields to moderate in the coming year, we would prefer to describe the 2022 surge in interest rates a “normalization” rather than an overshoot.

Among the strongest drivers of “70s deja-vu” has been the increase in labor union activity, political emphasis on unions by the US administration and high-profile labor actions.

This coming week, the United Auto Workers threatens a strike at one or more of the “big-3” auto producers.

According to the Wall Street Journal, Ford Motor company has offered workers a 9% wage increase over 4 years. The Union of Auto Workers asked for a 46% increase.

The US auto industry has been in a period of recovery from critical parts shortages this year and is only now beginning to satisfy unmet demand from 2021-2022. Labor friction amid technology revolutions (like electric vehicles) are just one reason why we don’t emphasize investments in industries that are capital-intensive, cyclical, and undergoing structural realignments.

While far from unimportant, the US auto industry has been diminishing as a share of economic activity.

A potential strike would have an impact on regional growth measures but is very unlikely to be decisive for the overall economy. The larger story of union power and strikes has mostly followed the same course.

The perception of severe labor action might seem high, yet the number and scale of labor disputes and strikes has stayed dramatically lower than the 1970s, as has union participation.

Overall, US labor costs have indeed gone up recently. But the gap between higher wages and falling profits is most similar to 2015, not 1975. Wage payments are decelerating presently to a 5.6% year over year pace. This is about half the 10.3% average pace of the 1970s.

The US Fiscal Policy Focus Is Different

The Fed is not following its 1970s course of neglect and the belief that higher inflation “greases the wheels of commerce.”

As the world public has certainly experienced the ugly side of inflation over the past two years, policy has tightened. The Fed has been convincing markets that it intends to see inflation curtailed to normal levels by 2024–25.

Only recently, markets have come to the view that a recession might not be needed to achieve this.

In 2020, monetary and fiscal policy created a short, sharp burst in inflation, larger than at any time in the 1970s. US broad money growth was 25% that year. But unlike the 1970s, the burst of monetary stimulus is not being sustained.

It is being reversed. US broad money (M2) has contracted 3.7% over the past year, the first annual decline since the late 1940s.

The Fed has swerved hard to convince the public that it is willing to risk a recession to contain inflation.

Consequently, long-term consumer inflation expectations and much consumer behavior suggests a marked difference from the 1970s. Present consumer long-term inflation expectations hover at 3%, not far above the pre-COVID period.

Citi Global Wealth Investments
Charlie Reinhard - Head of North America Investment Strategy
Lorraine Schmitt - North America Investment Strategy

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