Andrew Mulliner and Helen Anthony, Portfolio Managers within the Global Bonds Team, believe that inflation is much less rooted than the recent central banker rhetoric would indicate and that conditions are ripe for a near-term moderation in price rises.
- The recent pace of growth in money supply indicates that inflation is poised to fall as pandemic-related monetary support runs its course.
- Current drivers of inflation still hark back to the pandemic’s supply disruption and energy market volatility.
- Spending behavior and long-term inflation expectations indicate that consumers still view inflation as transitory.
Recently, it feels like the talk of inflation is all-consuming. From grocery stores to the front pages of every financial newspaper, rising prices – and their impact on daily lives – are on everyone’s mind. One only has to do a quick Google Trends search to see that since the mainstream adoption of the Internet, our current collective awareness of inflation is truly off the scales (Figure 1).
Figure 1: Internet Search Trends Show Unprecedented Interest in Rising Prices
Source: Janus Henderson Investors, Google Trends, as of 26 April 2022. Note: Interest over time numbers represent search interest relative to the highest point on the chart for the given region and time. A value of 100 is the peak popularity for the term. A value of 50 means that the term is half as popular. A score of 0 means there was not enough data for this term.
Perhaps most ominously for investors, what used to be couched as a “transitory” post-COVID price reversion has now started to sound much more rooted in policymaker rhetoric. Markets have priced in this change of attitude and are now bracing for a sharp tightening of monetary conditions from central bankers looking to regain credibility after a year of inflation “surprises” and accelerating price rises.
Faced with this once-in-a-generation phenomenon, commentators have started to look back in time to the inflationary wave of the 1970s for clues about what could befall markets. While it is easy to draw parallels with the '70s oil-induced inflation initially, a closer look at the drivers of recent price rises shows that the script for this latest wave of inflation is different. We believe that policy mistakes from central bankers pose the greatest risk to the economy right now. In short, we are more worried about the U.S. Federal Reserve than we are about inflation.
No '70s Replay
The main argument against a rerun of '70s-style inflation is monetary. What drove prices five decades ago was a sustained and significant increase in the money supply. While it is true that policies enacted to address the pandemic did cause the supply of money to rise at the fastest rate since the '70s, these have either run their course or been rolled back, which in turn triggered a sharp deceleration in the growth of new money over recent months.
Figure 2: Money Supply Growth Has Fallen as Post-COVID Monetary Support Rolls Off
Source: Janus Henderson Investors, Economic Adviser Simon Ward, Refinitiv Datastream, as at 28 February 2022.
We also see no repeat of the credit-led money creation of the '70s. In fact, bank lending activity has remained below the long-term average throughout the pandemic.
Historically, it has taken three years (33 months) for adjustments in the supply of money to be reflected in consumer prices. By this measure, inflation is already primed to retreat – right at the time that policymakers are starting to become much more militant about fighting it. This, in our view, raises the prospects that central bankers will tighten too far, too fast, which could cause significant harm to economic growth and trigger more market volatility.
Causes of Inflation Not Entrenched
We see the underlying cause of recent inflation as much less entrenched than the hawkish tone taken by central bankers would warrant.
If we analyze the factors driving inflation since the pandemic, it is evident that a significant portion is attributable to energy, food and goods – which all remain plagued by pandemic-related bottlenecks – rising oil prices and, more recently, the conflict in Ukraine. These sharp increases have all started to be reflected in the core inflation readings that usually instruct the views of policymakers looking to strip out volatile elements of the inflation picture that are not easily swayed by monetary policy.
Figure 3: U.S. CPI Data Show Inflation Remains Driven by COVID-Related Supply Shocks
Source: Janus Henderson Investors, Bloomberg, as of 28 February 2022.
We note that services inflation – which had contributed the lion’s share of inflation in the runup to the pandemic – has remained much more in line with long-term trends, even if it has started to tick up in recent months.
Although there is no hiding the fact that recent price increases have been broad, we still think the true underlying causes remain transitory and linked to the nature of the shock that the pandemic imposed on the economy.
We recognize that further inflation could trigger an “adaptive expectations” feedback loop where workers factor in persistent inflation in their wage settlement negotiations but expect this risk to moderate in the coming months as the bottlenecks that have been driving recent price rises start to ease.
The Federal Reserve Bank of New York’s consumer inflation expectation survey reflects this transitory view on inflation, showing that consumers expect inflation to moderate to 4% on a three-year horizon – significantly less than the 6% short-term expected inflation for the coming year. Long-term inflation expectations have also started to retreat from recent highs (Figure 4).
Figure 4: Long-Term Consumer Inflation Expectations Remain Stable
Source: Janus Henderson Investors, Federal Reserve Bank of New York, Survey of Consumer Expectations, Bloomberg, as of 28 February 2022.
Recent consumer sentiment surveys are also signaling that an easing of inflationary pressure is in the cards. The University of Michigan consumer sentiment survey has been trending at its lowest level since the Global Financial Crisis, indicative of a near-term drop in demand that would be deflationary in nature. Additionally, survey data show that consumers have been putting off large purchases – the opposite of what is usually seen when consumers expect further price rises and try to bring forward purchases to pre-empt price rises (Figure 5).
Figure 5: Consumer Sentiment Negatively Impacted by Inflation
Source: Janus Henderson Investors, University of Michigan (UoM) surveys of consumers, index values, as of 31 March 2022.
The challenge presented to policymakers in this round of tightening is that they will be pulling on levers that impact demand to try to address transient supply problems, which are largely exogenous to the monetary system. Threading the needle between rolling back the post-COVID monetary support while keeping growth on track will prove tricky.
Although some of the recent policymaker rhetoric can be attributed to a desire to regain credibility after having kept rates low for so long in this cycle, the risks that inflation continues to overshoot their targets cannot be ignored. However, we believe that these risks will fade in the near term as the erosion of consumer spending power and the conflict in Ukraine start to weigh on growth forecasts. In turn, we expect to see a dialing back of the hawkish language, which should relieve some of the recent market uncertainty.