Global inflation: be afraid, but not very afraid

TOWARDS the end of last year, the prevailing view in the investment markets was that the uptick in global inflation was transitory. Analysts pointed to economies bouncing back after Covid and the consequent supply-chain bottlenecks as the main contributing factors. The United States Federal Reserve Bank (Fed) at that point saw no reason to raise interest rates to combat inflation in the US, although it did begin to taper its inflationary bond-buying programme.

But a loud chorus of dissenting voices questioned the transitory narrative. These folk believed higher inflation was a more serious, long-term risk and questioned why the Fed had not already begun doing anything to counteract it.

Fast-forward six months. While supply-chain pressures caused by the Covid-19 pandemic have eased, the war in the Ukraine is having a major impact on the global economy, particularly regarding the supply of food and energy. And the Fed is raising rates.

Three weeks ago, the Fed raised interest rates in the US by 50 basis points (0.5 percentage points) after consumer inflation jumped to 8.5% in March. That’s the highest US inflation has been in over 40 years, and it was the biggest interest-rate hike by the Fed in over 20 years. Fed chairman Jerome Powell says more 50bp hikes are likely.

So the prevailing view has changed to the following: inflation is a bigger risk than everyone initially thought; however, it will come down from its current highs and, although settling at a higher rate than pre-Covid years, we are not likely to experience runaway inflation of the type that marked the 1970s.

At a recent press briefing on Old Mutual Investment Group’s (OMIG’s) latest annual Long-Term Perspectives report for investors, two portfolio managers from OMIG, Graham Tucker and Urvesh Desai, expounded on this view.

Inflation expectations

Tucker said inflation in Europe and the US had shot up quite dramatically as a result of supply-demand issues stemming from the Covid-19 pandemic and more recently the war in Ukraine. But he said this was likely to peak at some point soon if it hadn’t already. What concerned him more was medium- and long-term inflation.

The medium-term driver in the US, Tucker says, is wage growth: the economy is booming and unemployment is at record lows. “Companies have to pay people more to fill vacancies, so wages in the US have gone up quite sharply. The data shows that wages are rising across income bands and age groups, so it’s quite pervasive. We think this is going to be the biggest driver of medium-term inflation going forward and it will settle at a higher level than it was leading into Covid,” he says.

Tucker says the Fed is targeting 2% inflation in the medium term, although the US market’s medium-term inflation expectations have moved up to around 3%. “They haven’t moved up to the 7-8% that we’re seeing in the short term, but they are still moving higher. The Fed is starting to react to that, but it is clearly behind the curve and is now playing catch-up.”

Looking further ahead, Tucker says there are three global factors that are likely to contribute to higher inflation over the next 20 to 30 years: decarbonisation (companies are being forced to lower their carbon footprints); demographics (ageing populations); and deglobalisation.

“The globalisation drive over the past 40 years has been one of the biggest factors in bringing inflation down to lower levels. That is changing: the world is localising – or nationalising – again. That will put upward pressure on prices over the long term,” Tucker says.

Back to the 70s?

Desai agrees that inflation is currently a problem. “In the US it has been driven by an amazingly strong economy. In the rest of the world you’re getting some of that, but you’re also getting the impact from the Ukraine war on energy prices. In South Africa, although we’re dependent on overseas oil and energy, we don’t have a strong economy to push up prices, so we don’t have naturally buoyant inflation.”

Desai says there are good reasons why the world is unlikely to return to the rampant, runaway inflation of the 1970s, when global inflation peaked at about 14%. “The 1970s is the ‘bogeyman’ of inflation, but we are not expecting that over again. That was a very particular environment, especially in the US, where the level of monetary policy (the central bank’s control of the money supply) was not appropriate for the level of fiscal policy (the government’s control of revenue and expenditure).

These two forces act together: if they are both very stimulatory, you’ll have a problem and if they're both very restrictive, you’ll have a problem. In the ‘70s you had very stimulatory fiscal policies, which came out of a strong period of growth in the ‘50s and ‘60s, and you had monetary policy that was too accommodative for that level of fiscal stimulus, and that, together with the failure of Bretton-Woods (the post-war agreement that created an international currency-exchange regime based on the US dollar and gold), caused this runaway inflation.”

Desai says that monetary theory has advanced “light years” since then. “We’ve got the Taylor rule (using interest rates to control the economy) and inflation targeting. These mechanisms were not around back in the 70s; there was a different economic thought back then.

“The Fed is acting – they are not allowing inflation to run away. They’re behind the curve without a doubt, but they’re acting now. The risk is that because they’re behind the curve, they are a bit more aggressive and, with the lag making things more tricky, they do more than they need to and cause a recession,” Desai says.

Recession fears

Desai believes fears of a recession caused by the Fed acting too aggressively are overblown. However, a global recession triggered by geopolitical events in Eastern Europe may be another matter.

At a global economic outlook panel discussion at the World Economic Forum (WEF) in Davos, Switzerland this week, Kristalina Georgieva, managing director of the International Monetary Fund (IMF), said that since the IMF’s last forecasts the “horizon has darkened”. According to a WEF report, Georgieva was particularly concerned about food price shocks and how anxiety around the world over food supply was “hitting the roof”.

Georgieva was concerned about recessions in countries that had been hard hit by the pandemic and that rely heavily on imports from Russia for energy and food. But she insisted “we have not seen that yet”.