The 2% inflation era is over
Monetary policy tightening continues across all regions. The inflation problem is a global problem, and therefore the inflation fight is a global fight.
As policy rates across almost the entire planet move higher and higher, demand destruction will materialize, slowly at first due to the lag effect, but then explosively.
In the US, the central bank moved the policy rate up by 0.75% to 4.0%, making this rate hiking cycle the sharpest in history. In England, the central bank increased its Bank Rate by 0.75 % to 3%. Meanwhile, Norway’s central bank raised its main policy rate by 25bp to 2.25% this week.
Inflation and inflation expectations at elevated levels, if entrenched, become a serious and complex problem with multidimensional negative spillovers. Unfortunately, as Jay Powell said this week:
« We don’t have, you know, a clearly identified, scientific way of understanding at what point inflation becomes entrenched (…) The thing we need to do from a risk management standpoint is to use our tools forcefully but thoughtfully and get inflation under control, get it down to 2%, get it behind us; that’s what we really need to do and what we are strongly committed to doing. »
(FOMC Press Conference November 2, 2022)
In the fight against inflation, there will be several casualties, growth, jobs, margins, and prices of growth assets. We expect policy rates to move higher and stay higher for an extended period, unlike the Fed and all the other central banks, which are expecting to engineer inflation back to 2%.
The 2% target in a world where secular inflation is setting in and rising is not an achievable target any longer. The 2% inflation era is over. Below is the list of factors influencing secular inflation forces from our GMG Insights Secular inflation is the new normal — get ready (August 18, 2022).
From an investment and portfolio implications perspective, the inflation fight and the higher inflation era pose a challenge. We continue to be defensively positioned across all our discretionary mandates and have allocations to asset classes and regions which we expect can benefit from a higher inflationary environment and further geopolitical fragmentation — one of the key factors triggering secular inflation.
The chart below shows the US central bank policy rate in black rising sharply this year compared with the Fed’s projection for the policy rate in green and the longer-run projection in red. Inflation in the gray line should be viewed and compared with where the Fed expects it to be, the yellow line. Indeed monetary policy works with a lag, and the lag depends on many variables, including the efficiency and efficacy of the monetary and financial transmission mechanism. However, we believe the projections are unattainable.
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