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When will global inflation peak?

02 May 2022

Strong demand globally fueled by ultra-loose monetary policy and government spending has hit a surprisingly strained supply chain and limited capacity. The consequence is a sharp acceleration in inflation globally leaving the market to ask when will inflation peak, as central banks globally scramble to respond after years of ultra-loose monetary policy. Consensus is for this to happen this year, but uncertainty in the US prevails while central banks are now on the war path. How fast the global economy cools under central bank pressure will determine much of the global inflation pressure for the next few quarters. Three mechanisms are at work: 1. Wage inflation spirals 2. The war in Ukraine, with the risk of a natural gas embargo in the later stages of the war 3. Commodity prices.

United States – Inflation peak is hard to forecast
Inflation continued to surge a tad faster than expected to reach 8.5% in March, levels not seen since the early 1980s. There were some encouraging signs with weaker car and truck prices after a rapid acceleration. Some economists argue that the Fed would have to increase its fund rate to 5-6% to fight inflation leading to a deep recession. This is far out from consensus, but it does illustrate an important point.

  • The dynamics of a wage inflation spiral are hard to predict.
  • The impact of higher prices on demand are not straightforward: Earnings, the latest GDP print and the Gallup Economic Confidence (27/4/2022) suggest inflation is a concern, but is not strongly eroding demand.
  • Supply chain issues likely will be with us for a long time (e.g. China zero covid policy)

Inflation expectations are actually implicitly traded in the TIPS market and they suggest great uncertainty (see graph below). It is simply very unlikely inflation can stay elevated for so long without a recession or a policy mistake by the Fed. The Fed might guess somewhat better with sophisticated models, but the long lag in the economy’s response to monetary policy makes the prediction hard to pin down.

Source: Nordea Investment Funds S.A. and Bloomberg

Europe – The peak of inflation is very close, but the ECB has barely started tightening
ECB Vice President Luis de Guindos sees the peak of inflation as being very close (28th of April). The question is what happens in the coming months. 1. A wage inflation spiral is likely if the ECB stays so far behind the curve for long, irrespective of the growth shock from Ukraine. Over time, however, older forces such as an ageing population and the rapid transformation of mature sectors eventually are likely to prove deflationary. On the other side, ESG cost integration, from supply chains to energy, is likely to be expensive. 2. The war in Ukraine could lead Russia to eventually take on wilder retaliations against Europe as its war industry and logistic fails to keep up. That may mean cutting off natural gas exports to Europe leading Germany into a sharp recession and a significant spike in prices.

Commodities – Expensive
Oil prices are likely to stay elevated as OPEC+ maximizes rent while it still can. Commodity supply from agriculture (Ukraine, Russia), copper, natural gas et al will take years to increase after a long period of under-investments. The fact that commodities are expensive doesn’t necessarily mean it is significantly inflationary especially as it can depress global demand. What is inflationary is the slow but steady integration of ESG costs.

What does it mean?

Consensus and Nordea Group expect inflation to peak this year globally (see below). As inflation eventually peaks, we should see demand rebound leading to a recovery in earnings and fixed income. We are not there yet as central banks are tightening.
In such an environment, listed infrastructure continues to be a decent hedge against inflation. Companies with stable cash flows and cheap valuations continue to be of interest. Finally and most importantly, the long-term secular force of ESG remains.

Source: Nordea Bank Abp

Source: Nordea Investment Funds S.A. and Bloomberg

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