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In a recent white paper, " The Risk Of Higher US Inflation In 2026", Adam Posen and Peter Orszag argue that inflation could exceed 4 percent by year’s end. To wit, they lead the article as follows:
In our view, however, this optimism is premature. We think it is more likely that inflation will surprise to the upside—potentially exceeding 4 percent by the end of 2026.
Given that their 4 percent inflation forecast is well above Wall Street’s expectations, let’s review their case. In a section below, we rebut some of their arguments.
- Lagged tariff effects: Their belief is that foreign producers and importing firms took on the bulk of the tariff costs, but over time, they will pass them on to consumers.
- Large fiscal deficits: Fiscal deficits running greater than economic growth inject purchasing power into the economy, increasing demand and generating inflation.
- Tight labor markets: Fewer workers, in part due to immigration policies, drive wage growth and fuel service-sector inflation.
- Loose monetary policy: They believe rates are not restrictive enough, as the economy is running hot.
- Inflation expectations rising: If households and businesses expect higher inflation, such expectations change their consumption behavior, which can push prices higher.
Their conclusion:
Taken individually, lagged tariff pass‑through, tightening labor supply, looser fiscal policy, and accommodative financial conditions would each push inflation modestly higher. Taken together—and interacting with increasingly fragile household inflation expectations—they create a macro environment in which inflation rising above 4 percent by the end of 2026 is not only plausible but arguably the most likely scenario.
The Case Against 4 Percent Inflation
The following is our rebuttal to the arguments laid out in the opening section warning of 4 percent inflation.
- Lagged tariff effects: Tariffs tend to create one-time price-level adjustments rather than sustained inflation. Furthermore, History shows tariffs are usually disinflationary over time because they weaken growth and demand rather than create inflation.
- Large fiscal deficits: Today’s deficits are increasingly financing interest expense rather than direct payments to consumers, so they are not generating private-sector demand as during the pandemic. Moreover, high government debt levels crowd out private credit creation and tighten financial conditions, thereby negatively affecting growth and dampening inflation.
- Tight labor markets: Statistics such as job openings, temporary hiring, hours worked, continued jobless claims, and wages (shown below) suggest the opposite of the author’s concerns.
- Loose monetary Policy: Monetary policy operates with long lags, and the Fed’s tightening since 2022 remains historically large. Interest rates are restrictive, as evidenced by debt-sensitive sectors such as housing, credit, and small-business lending.
- Inflation expectations rising: Such is not true, as shown in the second graph below. Market-based expectations, as seen in TIPS breakevens and forward inflation swaps, remain anchored near the Fed’s target range. Consumer and business inflation sentiment are slowly falling.
Our concern is not 4 percent inflation or, as others argue, a return to 1970s inflation, but a continuation of the pre-pandemic trends, including slower nominal growth and periodic disinflation scares.
Blue Owl – The Owl In The Coal Mine?
Retail and institutional investors have been chasing private credit funds as speculative juices run wild in almost all markets. The surge in demand and liquidity pushed yields on the underlying loans to levels that were arguably too low, failing to adequately compensate investors for the risks involved. The recent bankruptcy of two high-profile loans and liquidity issues are raising concerns that some private credit investors may be in trouble. The situation got more dicey on Wednesday when Blue Owl’s (NYSE:OWL) private credit interval fund halted redemptions for investors. It’s worth noting that this fund is aimed at retail investors, not institutional investors. Per FT
Private credit group Blue Owl will permanently restrict investors from withdrawing their cash from its inaugural private retail debt fund.
Did the private loan markets go too far? In other words, did the strong demand for the product result in yields that didn’t properly account for the risks? Or, more broadly, are the recent issues a function of dwindling liquidity that could, in time, spread to affect larger, more well-followed markets?
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