Capital Ideas^TM

In this paper, currency analyst Jens Søndergaard answers key questions on the outlook for the global economy, covering the Russia/Ukraine conflict, inflation and currency views.

How has the Russia/Ukraine conflict impacted your global macro-outlook?

So much of the macro-outlook in the next 12 to 24 months is dependent on the outcome of the Russia/Ukraine conflict, particularly in Europe. In terms of the near-term impact, most economies will likely be stuck in a stagflation scenario with high inflation and outright GDP contractions. 

The longer-term impact puts the global economy even more firmly on a path of further de-globalisation - a process that really started in 2016 with the election of Donald Trump and accelerated further in 2020 with the pandemic. Rolling back globalisation implies an even slower trend GDP growth going forward and broadly higher government debt burdens.

What are your thoughts on inflation? Are we in the midst of a shift in the inflation regime?

To me, the most important inflation question is whether we are now exiting the “Great Moderation” era; the period we had from the mid-1980s to 2020, where policymakers delivered low (around 2%) and very stable inflation. This combination of stable and low inflation was one reason for the decline in bond risk premiums that we have seen.

It’s much harder now with supply side shocks that push inflation higher and growth lower. These include the energy and food price shocks resulting from the Russia/Ukraine war, but also de-globalisation, as companies onshore their supply chains. It is very possible we are moving towards an era where we have more “bad” supply shocks than “good”. 

Being hit by more “bad” supply shocks causes problems for central bankers as they can’t do anything about this type of inflation. For this to become more persistent in the next 10 years, all these one-off inflation shocks need to become firmly entrenched into inflation expectations and trigger persistent wage-price spirals, similar to the 1970s. That will only happen if central banks have given up on their inflation targets and effectively “fall behind the curve”. That is how policy regime shifts come about.

It is important to remember that the level of inflation is ultimately a political choice. Politicians have made central banks independent and tasked them with delivering low and stable inflation. It was easier in the pre-COVID world to deliver low inflation, without any policy trade-off between stabilising growth or inflation. 

The Fed’s inflation-fighting credibility is now being tested, and the markets are obviously very focused on what happens with US inflation dynamics in the next year. The key question is not so much when US inflation peaks but rather whether it drops quickly enough for the Fed to pause its rate hikes. I think there is a scenario in which this happens, but a lot of things need to go right, including oil prices falling and US wage growth moderating as the US unemployment rate rises.