By Robin Marshall, director, fixed income
Given the recent dislocation of global supply chains, some commentators have raised the prospect that inflation will return as aggregate demand recovers because of a negative supply-side shock from the coronavirus and its impact on capacity. Is this a legitimate concern?
Fixed-income markets currently think deflation is a greater risk
There is little evidence in fixed-income markets of inflation expectations recovering strongly. The chart below shows 10-year inflation expectations, as measured by breakevens, have stabilized somewhat after strong policy responses following the government imposed lockdowns, but remain well below the pre-coronavirus shock, and 2% inflation target, levels (note that UK breakevens are based on the RPI, and not the 2% CPI target). So, the challenge for central banks is more about preventing deflation expectations than controlling inflation expectations. The ongoing collapse in the price of oil is further evidence of this challenge.
10-year inflation expectations, measured by inflation breakevens
Source: FTSE Russell. Data as of April 20, 2020. Past performance is no guarantee to future results. Please see the end for important disclosures.
We could see a 2010-11 replay of price increases, but without a persistent inflation problem…
Food prices have been cited as a factor in a possible rebound in inflation, but it is important to distinguish between one-off factors that cause a temporary increase in the price level, and a permanent increase in the inflation rate (year-on-year). One-off increases in food, or commodity prices, simply squeeze real income growth temporarily if not supplemented by higher wage inflation and tight labor markets. Indeed, if food prices spike as economic activity resumes later in 2020, post-lockdown, this will compound the squeeze on consumption and activity.
….as recent US experience shows
The chart below shows this for the US in 2011, when CPI inflation rose to a peak of 3.8% y/y, after increases in food, utility and transport prices. But this spike in inflation merely compounded the squeeze on US real incomes, since wage inflation was only just 2% y/y at that point, and did not exceed 3% for another seven years. Thus, after peaking at 3.8% y/y in September 2011, US consumer price inflation rates fell sharply as the real income squeeze caused consumer expenditure to slow (see Chart 2).
US average earnings growth and CPI inflation
Source: FTSE Russell / Refinitiv. Data as of April 22, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
The scale of economic contraction from the Great Lockdown reduces inflation risks further
Finally, the scale of the collapse in global demand caused by the Great Lockdown should be borne in mind. The IMF stated last week that it will usher in the deepest recession since the 1930s depression, with a contraction of 3% in the global economy (compared with a contraction of just 0.1% in 2009 following the GFC). The downward pressure on wage inflation from the economic contraction makes building a case for genuine inflation risks in 2020/21 even more difficult.
Subscribe to our blog.
© 2020 London Stock Exchange Group plc and its applicable group undertakings (the “LSE Group”). The LSE Group includes (1) FTSE International Limited (“FTSE”), (2) Frank Russell Company (“Russell”), (3) FTSE Global Debt Capital Markets Inc. and FTSE Global Debt Capital Markets Limited (together, “FTSE Canada”), (4) MTSNext Limited (“MTSNext”), (5) Mergent, Inc. (“Mergent”), (6) FTSE Fixed Income LLC (“FTSE FI”), (7) The Yield Book Inc (“YB”) and (8) Beyond Ratings S.A.S. (“BR”). All rights reserved.
FTSE Russell® is a trading name of FTSE, Russell, FTSE Canada, MTSNext, Mergent, FTSE FI, YB and BR. “FTSE®”, “Russell®”, “FTSE Russell®”, “MTS®”, “FTSE4Good®”, “ICB®”, “Mergent®”, “The Yield Book®”, “Beyond Ratings®” and all other trademarks and service marks used herein (whether registered or unregistered) are trademarks and/or service marks owned or licensed by the applicable member of the LSE Group or their respective licensors and are owned, or used under licence, by FTSE, Russell, MTSNext, FTSE Canada, Mergent, FTSE FI, YB or BR. FTSE International Limited is authorised and regulated by the Financial Conduct Authority as a benchmark administrator.
All information is provided for information purposes only. All information and data contained in this publication is obtained by the LSE Group, from sources believed by it to be accurate and reliable. Because of the possibility of human and mechanical error as well as other factors, however, such information and data is provided "as is" without warranty of any kind. No member of the LSE Group nor their respective directors, officers, employees, partners or licensors make any claim, prediction, warranty or representation whatsoever, expressly or impliedly, either as to the accuracy, timeliness, completeness, merchantability of any information or of results to be obtained from the use of FTSE Russell products, including but not limited to indexes, data and analytics, or the fitness or suitability of the FTSE Russell products for any particular purpose to which they might be put. Any representation of historical data accessible through FTSE Russell products is provided for information purposes only and is not a reliable indicator of future performance.
No responsibility or liability can be accepted by any member of the LSE Group nor their respective directors, officers, employees, partners or licensors for (a) any loss or damage in whole or in part caused by, resulting from, or relating to any error (negligent or otherwise) or other circumstance involved in procuring, collecting, compiling, interpreting, analysing, editing, transcribing, transmitting, communicating or delivering any such information or data or from use of this document or links to this document or (b) any direct, indirect, special, consequential or incidental damages whatsoever, even if any member of the LSE Group is advised in advance of the possibility of such damages, resulting from the use of, or inability to use, such information.
No member of the LSE Group nor their respective directors, officers, employees, partners or licensors provide investment advice and nothing contained in this document or accessible through FTSE Russell Indexes, including statistical data and industry reports, should be taken as constituting financial or investment advice or a financial promotion.
Past performance is no guarantee of future results. Charts and graphs are provided for illustrative purposes only. Index returns shown may not represent the results of the actual trading of investable assets. Certain returns shown may reflect back-tested performance. All performance presented prior to the index inception date is back-tested performance. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. However, back- tested data may reflect the application of the index methodology with the benefit of hindsight, and the historic calculations of an index may change from month to month based on revisions to the underlying economic data used in the calculation of the index.
This publication may contain forward-looking assessments. These are based upon a number of assumptions concerning future conditions that ultimately may prove to be inaccurate. Such forward-looking assessments are subject to risks and uncertainties and may be affected by various factors that may cause actual results to differ materially. No member of the LSE Group nor their licensors assume any duty to and do not undertake to update forward-looking assessments.
No part of this information may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission of the applicable member of the LSE Group. Use and distribution of the LSE Group data requires a licence from FTSE, Russell, FTSE Canada, MTSNext, Mergent, FTSE FI, YB and/or their respective licensors.
