What you’re not hearing about the coming deflation

The Fed’s target for CPI is 2-1/2%, just where it was before the pandemic. When June CPI is reported in three weeks, it will be down from a year-before peak at about 9% to about 3%, most the way to the Fed’s target – yet Powell says it’s a long way off. Our monetarist model predicts it will be at target in July, and below target in August – and then will continue into outright deflation. At first the market reaction will be exuberant, and then the dread of deflation will drive a collapse in sentiment. But the price level is now already up 18% from before the pandemic, and only some degree of deflation can restore it toward trend. Because of the speed with which this inflation/deflation cycle will have taken place, it could be an example of “optimal control” in which a smaller mistake in the opposite direction of a prior large mistake is the best way to bring a complex system into balance. So a deflation scare later this year could provide a significant buying opportunity.