Blackrock has released its latest macroeconomic outlook note and makes a compelling case: Inflation is largely driven by supply shocks, not fiscal policy, and raising rates is not the answer.
It was largely due to manufacturing shortages and a shift in consumer spending towards goods rather than services.
We’ve heard it all before and it’s compelling. I think inflation will go away with the virus and we will be back in the post financial crisis economy. It’s the best case scenario.
Because if inflation persists and the Fed is forced to increase its fed funds to +4%, there will be a bloodbath in the debt market that will affect everything. Bonds are the biggest bubble in history and when the bubble bursts it will be catastrophic globally.
In any case, this is not going to be solved now.
What is happening now is equally interesting.
It is increasingly clear to me that people are feeling inflation. This should be evident with prices up 7% YoY in the US. What has changed is that higher prices are becoming more prevalent, especially in groceries and gasoline. Previously. it was limited to things like used cars and I think people could rationalize that.
Now people are frustrated and angry with rising prices. They’re looking for an outlet for it.
Naturally, they point the finger at politicians. Biden is skewered in the US for inflation, but as Blackrock argues, the fiscal side is a small part of inflation and the costs of not supporting the pandemic would have been unbearable. Moreover, Biden did no inflation in Germany, Canada, Brazil and almost anywhere else in the world.
But people need an outlet. They need someone to blame.
Inflation has sown discontent. People feel ripped off. At the grocery store, they go after the cashiers, but that’s just the beginning. A bunch of people feel like they are getting poorer despite all the government spending and stock market gains. It’s a dangerous cocktail.
As bad as it is in the developed world, it must be an order of magnitude worse in emerging markets. People just can’t afford the price increases under any circumstances. The Arab Spring began as a protest against food prices. The drama in Kazakhstan this year started due to rising propane and butane prices.
I don’t know where this ends and I’m not encouraged by the lack of confidence that fiscal and monetary officials are expressing on this. Anger drives them away.
“When supply constraints are responsible for higher inflation at a time when the economy has not yet returned to full capacity, there is a difficult choice to be made: either live with higher inflation or destroy the activity before it reaches full capacity,” Blackrock writes.
“The main risk we see is that central banks will put the brakes on if constraints persist and they perceive that higher inflation could fuel inflation expectations. This would be bad for bonds and equities as policy rates are rising to restrictive levels and slowing growth.Some of that risk may be priced in at times – like the past few weeks – as markets adjust to this new macroeconomic landscape.But if central banks hold back, they will likely learn that it costs too much and will be forced to reverse course. At points where this risk is priced in, yield curves will tend to flatten or even invert.”