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It feels as though US policy makers have spent the entire post-global financial crisis period trying to generate inflation. Now that it’s here, it seems like the wrong kind of inflation. How do you see inflation playing out in the US?

Inflation is clearly on the rise, but this should be expected when you shut down an entire economy, flood consumers with cash and then re-open the economy. The question is whether this inflation is likely to be transitory or persistent. It’s helpful to look at the supply side and the demand side of the economy separately.

In the short term, we are seeing very strong pent-up demand but restricted supply, and that's pushed inflation up, creating a challenge for the US Federal Reserve (Fed). Private and corporate balance sheets are very strong which has allowed the economy to bounce back quicker than we would normally expect following such a deep recession.

Another key consideration is the impact the new Omicron variant will have on inflation. If policy makers choose to impose tighter restrictions and enforce new “work from home” policies, this will likely slow the progress we’ve seen recently in the labour market and intensify supply-chain disruptions. In short, I think lockdowns extend the persistence of inflation. This is something to pay close attention to early in the new year.

I do think it’s important to differentiate between the short and long-term. There are big secular disinflationary forces that have been entrenched for decades and it will take more than a temporary supply and demand imbalance to stop or even reverse these. For example, there is still a lot of debt in the economy. Debt is essentially borrowing growth from the future, therefore high levels of debt put downward pressure on future growth, potentially leading to lower inflation in the long run. Inequality remains a big problem both in the US and globally, and arguably the wealth divide between the least and most well-off in society has widened during COVID-19. I believe inequality is disinflationary because money that flows into the wealthiest hands tends to be money that is saved rather than consumed. I think these secular disinflationary forces are important and, in the US, will likely keep long-term inflation benign and long-term bond yields low.

So, the outlook for policy makers is really uncertain. Since most of the uncertainty seems to lie in the short-term, I expect the volatility in interest rates to mainly impact short and intermediate maturity US bonds, rather than the long end.

This inflation challenge is not just a US phenomenon. How are you seeing inflation in other parts of the world?

I think the near-term inflation problem is very much a global one. In the UK, labour markets are incredibly tight. Following Brexit, many workers who previously filled low-wage positions in retail and hospitality have relocated back to Europe, and their labour cannot be replaced easily without the lure of higher wages. Demand has also been very strong as the economy rebounded, helped by relatively high vaccination rates.

 

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