US consumer inflation has been printing about 5% for three months – well above the Federal Reserve’s 2% target – and economic growth momentum is showing signs of waning, so stagflation has become the new buzzword. For some time, industry experts have been polarised on whether inflation will be a temporary phenomenon or a protracted problem. So who is most likely to be correct?
At Prescient, we rely on our systematic, evidence-based, unbiased and data-driven analysis to find answers to questions like this. Our proprietary model tells us that inflation is coming down, and economic growth is set to reaccelerate. Thus we don’t believe the world is heading into a lasting stagflationary period.
The latest August US Consumer Price Index (CPI) report suggests a temporary flattening of inflation at a high level. In the coming months, we expect inflation to remain elevated, as the earlier sharp increases in prices of some goods ease. On the one hand, once-off items, like used and new automobiles, have strong mean reversion characteristics. On the other hand, we expect prices like shelter to accelerate slowly. Next, businesses continue to increase product prices to offset sharp increases in production costs. Our analysis suggests that mean reversion will occur, but it will take another few months for inflation to ease in a more pronounced fashion.
Inflation is already far above the Federal Reserve’s (Fed’s) earlier inflation forecasts and its longer-run 2% target. As inflation has surprised the Fed on the upside, it has altered its definition of temporary versus more persistent inflation. The Fed acknowledges that the above-2% inflation in the last year has met its required make-up strategy. The most recent inflation report provides some relief to the Fed. But it is only one piece of monthly data, and the inflation story is not yet over. At Prescient, we continue to monitor inflation cautiously, relying on our deep and point-in-time analysis of big data sets. The future inflation trajectory depends on the pace of aggregate demand in the economy, how long supply constraints persist, and how much higher inflationary expectations influence price and wage-setting behaviour. We anticipate inflation will eventually recede, but we remain on the lookout for upside surprises.
On the economic front, we continue to see a good foundation for long-lasting, sustained economic growth. Combining this with lower inflation in the months to come speaks to our view that any current concerns around stagflation are overdone. The Delta wave of Covid-19 infections posed the biggest risk to our expectations of a more pronounced, lasting economic recovery globally. This applies to the US more so than to the better-vaccinated countries of Europe. But so far, the evidence continues to support the key assumption that underpins our positive economic outlook: vaccines are working. They have weakened the link between infections and serious medical complications so decisively that Europe and the US will likely not have to reimpose significant restrictions to economic activity.
Lower inflation and higher economic growth would be tailwinds for risk assets and underpins Prescient’s optimistic house view. What are the risks to our view? Our research suggests that higher US inflation does not necessarily pose a problem to South African equities or bonds. The true test will come once the Fed moves to a more restrictive monetary policy than the market is pricing in, particularly if it tightens financial conditions to the point that it is difficult to handle for global economies. While this is a real risk, it’s not our base case. Again, it will be our point in time, data driven-approach that helps us identify and process information in the timeliest fashion, always ensuring that we adapt quickly and remain well-positioned for whatever challenges the future holds. DM/BM
By Bastian Teichgreeber – Chief Investment 0fficer, Prescient Investment Management.
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