Adieu Galloping Inflation?

Until 2021, the global economy had experienced a long period of disinflation, characterized by progressively lower increases in key consumer and producer price indexes, culminating in an inflation rate broadly consistent with central bank target (i.e., 2 percent). Indeed, in most developed countries the actual level of price increases had persistently fallen short of that target and Japan, figuratively speaking once able to live to its reputation as the “land of the rising sun,” had been unable to shake off the shackles of chronic deflation. This had provided a highly favorable backdrop for the equity and fixed-income markets, which had kept on scaling new heights with merely occasional interruptions.

As documented previously, Covid-induced supply chain fragmentation, misguided pro-cyclical fiscal and monetary policies, and a sharp deterioration in geopolitical dynamics and governance have unleashed an economic storm in the form of a relentless upward pressure on consumer and producer prices, precipitating a decisive shift from an ultra-easy monetary policy to a tight posture. The equity and fixed-income markets’ joyous ride has thus come to an abrupt and painful end, with hardly any “safe havens” offering tangible relief.

Tentative evidence is beginning to emerge that the worst may be over. The U.S. headline and core consumer price indexes rose by 7.7% and 6.3% respectively in October on a year-on-year basis, which was comfortably below market expectations.[1] China continues to experience disinflation on the consumer front, up 2.1% in October, and has now fallen into deflationary territory on the producer front, down 1.3% in October.[2] The latter figure is quite significant because the U.S. normally follows with a modest lag.

Additionally, and perhaps more importantly, the trimmed consumer price index, which systematically discards 8% of the constituents at both ends of the basket and is a far more reliable gauge of underlying inflationary pressures than the traditional core variant, which mechanically removes energy and food, appears to have peaked and is gently trending downwards.[3] Moreover, the sticky consumer price index, which focuses on its least flexible components, seems to be following a similar pattern.[4]  Underperforming growth stocks have also staged a recovery after reassessing the inflation outlook, although expectations of a gridlock in Washington, which did not really materialize, may have been a factor fueling their burst of optimism.[5] Needless to say, the beleaguered fixed-income market has embarked on a massive rally[6] and the previously resilient USD index is showing signs of succumbing to gravity.[7]

It is too early to throw caution to the wind. The labor market remains surprisingly and stubbornly tight. By the same token, the disinflationary impulses operating in the goods sector have not yet significantly manifested themselves on the service side of the economy. The latter are more difficult to neutralize than those found in the goods space. Curbing price pressures may thus be a multi-month affair and interest rates are not likely to reverse direction for some time. Still, a turning point has apparently been reached and this may prove sufficient to prevent forward-looking financial markets from falling into the abyss again.

[1] See https://www.cnbc.com/2022/11/10/heres-the-inflation-breakdown-for-october-2022-in-one-chart.html
[2] https://www.focus-economics.com/countries/china/news/inflation/inflation-falls-to-lowest-level-since-may-in-october
[3] See https://www.clevelandfed.org/indicators-and-data/median-cpi.
[4] See https://www.atlantafed.org/research/inflationproject/stickyprice.
[5] See https://www.cnbc.com/2022/11/07/stock-market-futures-open-to-close-news.html.
[6] See https://www.wsj.com/articles/easing-inflation-ignites-bond-market-rally-1166809906.
[7] See https://www.cnbc.com/quotes/.DXY.

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