So why has inflation been waiting in the wings for so long? Firstly, several deflationary D’s: debt, demographics, disruption, digitisation and détente’s globalisation. Secondly, the era of central bank inflation-targeting. Lastly, what our Chief Investment Officer Henry Maxey calls ‘refrigeration mode’ – the disinflationary feedback loop between China and the West. Rapid industrialisation, urbanisation and growth for China in exchange for consumer indulgences and keeping inflation and interest rates low and stable in the United States. This system had amplifiers: in financial markets quantitative traders and trend followers; in supply chains, the bullwhip effects of ‘just in time’ systems which prioritised optimisation over resilience.
This shaped the economic and market landscape of the past few decades. It encouraged hyper-financialisation whereby the US has optimised its economy around asset prices. The result? Soaring c-suite pay, ballooning asset prices, rising inequality and corporate short-termism. Central bankers were complicit, openly targeting financial conditions as the transmission mechanism to the real economy.
Now this is all in flux. Powerful social reactions to wealth inequality, climate change and Cold War II (the containment of China’s geopolitical ambitions) have leapt to the top of the agenda. The shifting of these tectonic plates is inflationary. Wealth inequality calls for deficit-financed Universal Basic Income, ‘stimmys’ (stimulus cheques), and debt forgiveness. The climate transition will be extraordinarily expensive – the International Energy Agency estimates achieving net zero by 2050 will require investment of around $4-5 trillion per annum (around 5-6% of global GDP).1 Chinese ambitions and pandemic realities have forced companies to move from ‘just in time’ to ‘just in case’, prioritising robustness and adding cost. The lines between monetary and fiscal stimulus have blurred and, as they coalesce, the overall policy mix becomes more inflationary – more like a magic money tree (MMT). This system has amplifiers too – technology – because social media can amplify inflationary trends and digital money enables depositors to exit fiat currency in a heartbeat.
This fragility is evident in bond and equity markets, where duration (or sensitivity to the price of interest rates) is at an all-time high.