By Dr Renée Friedman
Our new macro blog will be taking a weekly look at what has happened in the world of global economics and finance over the past week and what it means looking forward.
Over the last week, equities markets were hit by the collapse of Evergrande in China while bond and currency markets reacted to warnings from the heads of various central banks that inflation would be on the rise until at least the early months of 2022.
This is due to increasing consumer demand as economies reopen, labour shortages in key sectors (transport being just one area), rising commodity and raw material prices, and the continuing shortages in shipping containers. In fact just how «transitory» inflation will be is being increasingly questioned by bondholders and currency traders as continued dollar strengthening hits yields.
The energy price rise (in gas and oil) has yet to feed through and will only exacerbate inflationary pressures. And these rises are likely to be a little more permanent than investors perhaps initially suspected as the rising costs of carbon emissions permits (in Europe and some other countries) and curbs on the usage of dirtier fuels, e.g. in China, are bedded in. Expect the central bankers to keep a close eye on cost-push inflation that will affect profits in addition to the possibility of spreading wage-inflation that already seems to be hitting some sectors such as hospitality, construction, and transport.
Things to look out for this coming week:
- On Friday preliminary Euro CPI data will be in and will be closely watched given the recent comments by the ECB about the «transitory» nature of inflation. Note the Eurogroup meeting of Finance Ministers takes place on Monday and will be followed by the ECOFIN meeting on Tuesday. Also look out for Euro market PMI (composite) on Tuesday and Retail sales data on Wednesday which should point towards just how well the Eurozone’s recovery is doing.
- In the US we’ll be looking at ISM Manufacturing numbers on Friday, US factory orders on Monday, ADP employment on Wednesday and job claims on Thursday as all will be closely watched given the nature of the Fed’s remarks last week on balancing inflation and employment.
- On Tuesday UK PMIs should give an indication of the condition of sales and employment while Thursday’s Bank of England credit conditions survey will give an indication of how households and small businesses are faring and where credit spreads may be heading in the UK.
Is there a stagflation monster hiding in the shadows?
The US and UK continue to show slow and steady strides while Europe, despite its overall positive growth numbers, seems to have a bit of a bumpier recovery experience. At the same time inflation has returned, causing a whole generation of young bankers to have to actually read those chapters they skipped in their university economics textbooks just so they can get their heads round this strange concept.
Although bonds sold off following Fed Chairman Powell’s comments, when he made clear that a taper was more likely to happen sooner rather than later and that there indeed actually was a rate rise in the almost foreseeable future, the continuing inflation threat makes tighter monetary policy and expected steady upward growth no longer a reflation trade. Between this and the threat of slowdown in China, no wonder equity markets took a bit of a tumble in September
But hang on, this is, we are being assured by these central bank presidents, like children being told that there is no bogeyman under the bed, only a transitory situation, this is not going to be a repeat of the super cycle of 1970s or 1980s style inflation.
However, It is becoming increasingly clear that inflation will remain above the 2% target of central banks for longer than central banks have been wanting to admit (I’m looking at you ECB President Lagarde). This is due to continuing supply bottlenecks and disruption, shortages of some commodities as well as some critical intermediate inputs,(e.g., semiconductors), a rebound in energy prices (oil, gas and electricity), uncertainty about the further spread of Covid as we move into the Autumn and winter seasons, rising food prices, and labour shortages, both in terms of numbers and the right mix of skills.
Wait, they say. It is only temporary imbalances between supply and demand and please stop looking in the wardrobe and go to sleep; really there is nothing unexpected there. But is there? What if the economic slack in these economies does not decline significantly? Or if Covid rears its ugly head in yet another new variant or the pass through of recent commodity price rises takes longer due to continuing supply and infrastructure problems? And what if food prices continue to rise due to climate change and extreme weather events, what then? Could we actually be looking at a stagflationary period? Instead of a bedtime story with the happy ending of Pride and Prejudice will we instead be getting a version of Bleak House’s Jarndyce v Jarndyce?
Although the stagflation of decades past is hardly likely to reappear like the ghosts of A Christmas Carol, it does imply that we may be heading for a period of sustained slower growth and higher inflation than policymakers wanted us to believe. If this happens, then central banks will be torn between fighting inflation or increasing employment. Given rising public (and private) debt levels and the continuing re-shoring of some sectors (see) the choice is not an easy one. If they go for the latter, then inflation would continue to be fed by loose monetary and credit policies. If they go for the former then bond yields will continue to rise and stock markets fall. In the interim all we can do is keep the bedside light on and keep a look-out into all corners of the room.
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