Daily Brief - The little chart that the Fed doesn’t want you to see

There’s a long-lasting relationship between growth and inflation: inflation follows the change in growth from last year - the ‘growth impulse’ if you will.

If last year the economy was in contraction and today in strong expansion, then prices rise. And vice versa. You will see how this worked in the past in the charts below.

Why does this happen, you ask? The traditional response is that supply chains are slow to adjust. If last year they cut capacity due to slow growth, this year they can’t cope with high-growth demand - and so they raise prices.

Educational parentheses: ISM New Orders is a survey indicator based on asking companies ‘Do you expect more or less orders next month?”. The indicator is centered around 50 which is the neutral value. When it is above 60 we’re in a good economy. It dips below 30 during serious shocks like the GFC or the Covid lockdown. The blue line below shows the change in ISM, which is a form of ‘growth impulse’.

So we come to the reason for a dovish view on inflation. In the scatter chart further down you can see the growth impulse / inflation relationship in the last decade.

Currently growth has been flat for 12 months, and supply chains are adjusting. This should help reduce the rise in prices going forward.

As always, myriad factors move the economy and one cannot look at a single indicator to expect a perfect forecast. This analysis is but one of the pieces of the puzzle - but one worth considering, before investors throw equities and bonds out with the bathwater.