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Are we past the peak of inflation fear?
After one of the worst years for global economic growth in 2020, this year looks set to be one of the best. Indeed, the bounce in activity is greater than many expected just a few months ago. Nevertheless, uncertainties around the economy remain, with inflation currently one of the most prevalent concerns. In the latest Quarterly Market Review for Q3 2021, EFG’s economists investigate the underlying inflation trend.
For the G20 economies in aggregate, real GDP was already above its pre-Covid level in the first quarter of 2021. That recovery was led by China; but South Korea and Australia were also above their pre-Covid levels. While the outlook is certainly rosier than before, one major economic uncertainty for the months ahead relates to inflation. A rebound in inflation has been seen in many economies, notably the US. There are concerns that this may herald the start of a new, more inflationary period for the world economy; but most central banks, as well as many private sector forecasters, see this as temporary. For now, we are probably at a time of ‘peak inflation noise’: discerning the underlying trend is much more difficult than usual.
There are two main concerns relating to the consumer price inflation trend. The first is that it may be pushed up by higher wages. From bar staff in Britain to stevedores in San Francisco, labour shortages are seen around the world. A broad sweep of UK economic history shows that wages, driven higher by labour shortages, have typically risen sharply in the aftermath of pandemics. However, the rise in wages tends to be temporary; and the general trend for several years after the pandemic is for lower, not higher, consumer price inflation. The reason, broadly, is that subdued demand tends to be a more important factor than supply shortages.
That suggests that the second inflationary force – supply shortages of semiconductors, new cars and building materials, etc. – may also not be long-lasting. Indeed, there are already signs of these shortages being corrected in the US, the advanced economy which has opened up the fastest.
The US has been attracting most of the inflation attention given its multi-year highs. It does however seem likely that the headline CPI inflation rate, which rose to 4.9% in May, will come down later in the year. The Fed’s preferred measure of inflation (the core PCE price index) is already lower than that (3.4%) and 5-year forward inflation expectations have scarcely moved, suggesting that markets are not too concerned about longer-term prospects. However, there have been some big swings in bond prices so far this year, partly reflecting the difficulty financial markets have had in ascertaining the inflation outlook.
The price of the benchmark US 30-year Treasury bond fell by 17% between the start of the year and mid-March, before recovering. That meant that on 1 July 2021 30-year yields stood at 2.1%. That is perhaps the soundest endorsement that financial markets could give of the credibility of the Fed’s 2% inflation target in the long-term. On balance, therefore, we tend to be sanguine about inflation prospects, a message which the US bond market also seems to have accepted.
This is just one of the topics discussed in the latest Quarterly Market Review for Q3 2021. To discover more about how economies are faring in individual markets or regions – from Switzerland and the UK to Asia and Latin America – or to delve into a special focus article on financial disruption, you can access the full Quarterly Market Review here.