Blackrock is out with its latest macro perspectives note and it makes a compelling argument: Inflation is largely driven by supply shocks, not fiscal policy and raising rates isn’t the solution.
It’s been largely driven by manufacturing shortages and a shift in consumer spending into goods rather than services.
We’ve heard all this before and it’s compelling. I think inflation will go away along with the virus and we’ll be right back into the post-financial crisis economy. That’s the best case scenario.
Because if inflation sticks around and the Fed is forced to hike to +4% levels in Fed funds, there will be a bloodbath in the debt market that spills over to everything. Bonds are the biggest bubble in history and when the bubble pops it will be catastrophic, globally.
In any case, that’s not going to be solved right now.
What is happening right now though is equally interesting.
It’s increasingly clear to me that people are feeling inflation. That should be obvious with prices up 7% y/y in the US. What’s changed is that higher prices are becoming more widespread, particularly in groceries and gas. Previously. it was confined to things like used cars and I think people could rationalize that.
Now, people are frustrated and angry about rising prices. They’re looking for an outlet for that.
Naturally, they’re pointing at politicians. Biden is being skewered in the US for inflation but as Blackrock argues, the fiscal side is a small part of inflation and the costs of doing no pandemic supports would have been unbearable. Moreover, Biden didn’t make inflation in Germany, in Canada, in Brazil and almost everywhere else in the world.
But people need an outlet. They need someone to blame.
Inflation has seeded discontent. People feel ripped off. At the grocery store they’re taking it out on cashiers but that’s only the beginning. A swath of people feel like they’re getting poorer despite all the government spending and stock market gains. That’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 simply can’t afford the price increases under any circumstances. The Arab Spring started out as a protest against food prices. The drama in Kazakhstan this year started out due to propane and butane price hikes.
I don’t know where this ends and I’m not encouraged by the lack of confidence that fiscal and monetary officials are expressing around it. The anger has them running scared.
“When supply constraints are responsible for
higher inflation at a time when the economy is not yet back to full capacity, there is a difficult choice to be made: either
live with higher inflation or destroy activity before reaching full capacity,” Blackrock writes.
“The primary risk we see is that central banks hit the brakes if constraints persist and they perceive that higher inflation
could feed into inflation expectations. This would be bad for bonds and stocks as policy rates rise to restrictive levels and
slow growth. Some of that risk may be priced in at points – like in recent weeks – as markets adapt to this new macro
landscape. But if central banks do hit the brakes, they will likely learn that it comes at too great a cost and will be forced
to reverse course. At the points this risk is priced, yield curves will tend to flatten or even invert.”