The long-awaited end of easy money seems to be upon us. In recent weeks, the Bank of England has raised rates, and the US Federal Reserve has indicated a faster decline in its asset purchase program and as many as three interest rate hikes in the year ahead. It’s all based on the idea that “Perishable” inflation becomes more permanent and moves from commodities and durable goods to areas such as wages and services.
Much of the debate over growth, inflation, and stock markets has revolved around the secular shifts we may or may not enter. But what if the only constant in the next few years is volatility? What if inflation dynamics that appear to be entrenched begin to oscillate? I think you can argue that this will be the case for a number of reasons.
First, the ripple effects of the pandemic created an inflationary environment unlike in the 1970s, the last time the US had a long period of inflation. Covid has created a series of asynchronous recessions and recovery around the world. The US is running “hot”, but China, which has been trying to defuse its property and debt bubbles, has cooled. The fact that these two poles of the disconnect world economy, not only in terms of trade and capital flows, but also their growth patterns, make it more difficult to predict how inflationary pressures will play out.
This is just one of the many factors behind which investment research provider TS Lombard dubbed the “biflation” trend, in which multiple supply and demand factors push and pull against each other in unexpected ways. For example, while the world has adapted to the sudden “high Covid” demand for everything digital, as well as pandemic-specific goods such as medical equipment, personal protective equipment and household goods, there may still be some post-Covid 19-stock be shocks in services, which had little reason to invest over the past two years, leaving little spare capacity.
This has already led to wage pressure. In the US, where services make up the majority of the economy, companies expect wage costs to rise 4 percent in 2022, as salary budgets reach a peak of 14 years, according to the Conference Council, a brainstorm. There is a generation of complexity to it all. “Rising wage growth, especially among younger workers, has compressed the typical premium offered to more experienced workers – who in turn are looking for new opportunities in a hot labor market.”
At the same time, companies may be in a round of price modification that will also lower profit margins. Although there has been a huge demand for goods over the past few years, we may soon see an abundance of inventory at manufacturers and retailers as retailers guard against over-purchases. A research report by Deutsche Bank in December noted that “retailers are over-ordering before the busy holiday season” while “manufacturers are producing and holding much more stock than they did before Covid”. According to the Bank for International Settlements, “the mechanical effect on CPI may become disinflationary ”as supply chain disruptions and“ precautionary storage behaviors ”decrease.
This will inevitably cause deflation in goods, even if there is inflation in services. The sharpest upward shift in spending in recent years has been in areas such as outdoor entertainment, restaurant dining, movies and theater. But it can also change quickly based on the trajectory of Covid-19 variants, such as those of ours with canceled holiday plans saw.
All of this creates what the BIS recently called a “bullwhip effect,” in which efforts to correct immediate inflationary issues create their own complex, delayed ripples that further distort prices. The geopolitically-driven shift from efficiency to resilience in supply chains, which will favor everything from localized production to new sovereign-backed digital currencies, will further hamper economists trying to model inflation with data from the past half-century.
Technology is the final game map. Artificial intelligence means it can do more of what humans can; 5G and the Internet of Things increase business efficiency. Both are deflationary. But that’s just part of the story. Remote work, for example, lowers commercial property prices but increases those of homes. Robot installations (12% more in the US this year) will be good for companies trying to keep prices low, but bad for the unemployed who are facing increases in fuel and food costs.
The result? I think we’ll probably see back and forth messages from central bankers struggling to figure out where things are headed next. Add to that the historical issues of debt and asset bubbles of decades of declining rates and unprecedented quantitative easing, and you have one of the most complex environments in which monetary policy can be made. If someone deserves a salary increase, it’s the people trying to figure out where inflation is headed.