- Strikingly, bringing down the post-pandemic inflation surge did not entail a global recession.
- Nor was it necessary to have a crash in asset prices or a collapse in confidence.
- We see a key factor being the quick softening of commodity prices.
- Strong supply side response and China’s weak demand drove this.
- We consider four key factors that bear watching in an otherwise benign price climate.
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Commentary: End of inflation?
Last week’s 50bps rate cut by the US Federal Reserve marked the end of a concerted global effort to fight the post-pandemic inflation surge. Inflation peaked in the summer of 2022, but it was followed by a prolonged period of anxiety with the respect to the outlook for prices. Some volatility in the data ensued, which appeared to threaten the path toward orderly disinflation. All that seems firmly behind now.
The welcome demise of inflation pressure did not entail a recession or a spike in unemployment, nor did it necessitate a crash in asset prices or a collapse in consumer confidence. The sharp rise in interest rates pursued by most major central banks in the world was absorbed remarkably well by the debtors at the household and corporate levels. Some distress was seen among several developing sovereign debtors, but that did not amount to manifestations of any kind of global systemic risk. Indeed, multilateral lending institutions engaged with the borrowers and lenders to manage the sporadic episodes of sovereign balance sheet stress. Some US regional banking faced difficulties in early 2023 owing to duration mismatch as rates soared, but that was dealt with swiftly by the Fed, with no global fallout.
How did the great escape happen? We think the answer lies in commodities. Just when supply chain disruption and other pandemic related distortions were beginning to ease in early-22, Russia’s invasion of Ukraine caused a great deal of uncertainty about the price of food and oil/gas shipment worldwide. The following months were marked by peak inflation fear. Along with the cyclical issues were looming structural worries, from climate change to aging. The era of high inflation and rates seemed to have arrived.
But it has all turned out to be transitory. Global production and supply of food and energy have proven to be resilient, with soft demand from China also playing a moderating role. Against most expectations, commodity prices began to decline from 2H22 onward, and have remained soft through the past two years. Case in point is oil, which is presently trading nearly 40% lower (in real terms) than the peak of June 22. Compared to the all-time high (back in 2008), oil is down by 60%. This dynamic, to us, explains the journey of inflation and the global economies’ ability to the absorb the 21/22 inflation shock better than any other.
Worries over global inflation have abated, although we will track four key factors ahead:
First, global shipment costs, if they spike due to geopolitics, could be a spoiler.
Second, US policy. If expansionary fiscal policy persists, it could weigh in on the dollar and a wide range of tradable goods. Tariff war is another element.
Third, the direction of asset prices supported by lower rates and their spillover impact on consumer demand. This is the “melt-up” risk we have flagged previously.
Fourth, China. Unlike the rest of the world, China has been grappling with weak demand and deflation risks. If and when ongoing efforts to revive the economy bear fruit, that could get the prices of metals/energy going again, which in turn could be consequential to global inflation.
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