Could a policy error spell trouble for markets?
The biggest question on most investors’ minds in the first half of 2021 has been ‘will inflation be transitory or lasting?’ While the issue is far from settled, the consensus is - increasingly - with the former.
But just how long can transitory last? Long enough to potentially cause a policy error from central bankers, says Charlie Jamieson from Jamieson Coote Bonds.
“Transient (inflation) could hang around just long enough to be uncomfortable for central bankers. That can potentially force a policy error. We’ve seen them do it plenty of times in the past.”
In this video, Charlie explains some situations in which inflation could persist and what it would take to get there.
Why do you believe inflationary will be transitory?
This word, transitory, gets bandied around a lot at the moment. Transitory for us is not a matter of months, but it's not years and years either. The reason we expect it to be transitory is two-fold. Firstly, the rise in the base effect. That goes all the way back to having negative oil prices last year, which was tremendously deflationary, but destroys the year on year data basket so you've got these really negative numbers. As they fall out and we load in normalised numbers, clearly the whole thing lifts massively. That's basically just occurred. That is the inflation hill and we wrote a white paper about that earlier in the year. That's definitely gone, mathematically gone. That's the easy bit. The hardest bit is working out, what's going to hang around as a result of these supply blockages. We know that they've been intense as we've gone through rolling lockdowns around the world.
We know that as everybody comes out of lockdown, they all want to do the same thing together, which is get the hell away from where they've been locked down and travel and things like airfares and lodging away from home, car rentals, those prices have gone through the roof. That's pretty understandable, I think. But there is a point at which if they continue to rise, that we'll see severe demand destruction. You simply just not going to go on holidays where you paid two or three or $400 a night for accommodation, if it's at 7, 8, 900, and keeps rising. So inflation needs to be continuously rising. I think as a result of what we've gone through, we've seen some one-off price increases, no doubt, but the sustainability of that we think will come into question and should moderate back to trend once we get through this reopening process.
We've had huge amounts of logistical challenges. We've had shipping containers on the wrong side of the world. We've had blockages in the Suez Canal. Everything we could throw at these logistical supply chains has simply occurred and it's just picked up the jigsaw and thrown it in the air and the pieces have landed all over the floor in regard to the jigsaw puzzle. We do need to let that calm down and we think that transient will result out of that. I'm pretty sure the next question you're going to ask me is, do central bankers care about that?
I think transient can hang around just long enough to be uncomfortable for central bankers, and that can force potentially a policy error. We've seen them do it plenty of times in the past. We've seen the Fed obviously be a little bit more aggressive about their take on average inflation targeting. And so in doing that, clearly they're destroying future inflation expectations in terms of market pricing, but it is a little bit problematic for them. It's just elevated enough and it's not going to fall away quickly. After the GFC we saw this kind of inflation hang around for six to 12 months. Certainly, we're not at day one, but it is just hanging around a little bit and we do expect it to moderate. We don't see broad secular changes in the inflationary environment, but there's lots of these one-offs and they're going to take some time to moderate out.
What would have to change for inflation to become more permanent?
The three very obvious ways to get sustainable inflation. One is to have a really big war. One is to have a really big energy crisis or the third one, which we'd all hope for, is to have full employment. We really do need that full employment in order to get there. I think options one and two don't look very desirable for anybody. Option three would be fantastic, but there is enormous amounts of spare capacity in economies. We know that a lot of these jobs that have been destroyed as a result of lockdown, they're not likely to come back quickly. So we're still some ways away from that.
Now that's a bit different here. We've got closed borders at the moment. Obviously, prior to this Delta outbreak that we're experiencing at the moment, our employment situation was looking really good because we don't have to have this crowding-out effect from all of these internationals coming in to fill a lot of these openings. But yeah, I think that full employment's the obvious one in Australia today and essentially the whole East Coast up to the Sunshine Coast from Melbourne is in lockdown or some form of rolling lockdown. We saw early in our COVID journey via the suppression strategy, we'll be one of the last out, whereas a lot of other countries that have had chaotic and brutal COVID experiences have at least passed through them now. So thinking of places like the UK, you've either had it or you've been vaccinated. One way or another, you've got some immunity, they're going to be moving on beyond COVID, similarly in the US.
In Australia, it's just going to take more time, and certainly, it doesn't look like government policy will change around living with COVID anytime soon. So, frustratingly, we're going to be one of the last out and that's going to be complex for our own employment situation.
Strengthen your portfolio with global high-grade bonds
In times of uncertainty, adding high-grade bonds to your portfolio can provide much-needed stability, liquidity and diversification. Find out more here
MORE ON Macro
1 contributor mentioned