Is inflation still a problem or not? There is a tussle going on between those who believe inflation is falling in a sustained and structural way, and those who believe inflationary pressures are set to persist in 2024. The conclusion on where inflation will land is likely to be a key determinant for returns in the year ahead.
The negative view on inflation is being led by central banks themselves. For example, Andrew Bailey, governor of the Bank of England, has said that the Monetary Policy Committee’s projections “indicate that monetary policy will likely need to be restrictive for quite some time yet”. He said food and energy costs pose an upside risk, while services inflation remains “much too high”.
After the Federal Reserve meeting in November, Jay Powell said: “We are committed to achieving a stance of monetary policy that is sufficiently restrictive to bring down inflation to 2% over time and we’re not confident yet that we have achieved such a stance.” Central banks are striving to ensure messaging on inflation remains tight and no complacency creeps in.
Yet inflation continues to tumble. US CPI data showed inflation running at 3.2% in October, prompting financial markets to eliminate almost entirely the possibility of near-term rate hikes. Even in the UK, where inflation has proved stickier, it came down from 6.3% in September to 4.7% in November. A slowdown in energy prices proved important with oil prices shaking off the crisis in the Middle East to fall from $87 a barrel in mid-October to $75 today.
David Hogarty, senior portfolio manager and head of strategy development at KBI Global Investors is firmly on the side of the central banks. He says: “We think inflation won’t come under control. You’re going to have periods where it dips and rises, but we don’t believe we will get near 2% for a very long time. There’s lots of data that shows once inflation gets beyond 4-5% it takes almost a decade to get back to 2% again. We think we’re in for higher levels of sustained inflation and ever-increasing bond yields.”
Willem Sels, HSBC Private Bank, agrees that services inflation is a particular problem, notably in the UK. He says: “In the case of the UK, a lot of the fall that’s been seen is due to base effects and further progress will be more difficult. Wage inflation in particular is a sticking point…In manufacturing, the input costs are falling faster than the output costs, which is a favourable situation, but services are where sticky inflation is. Input inflation is higher than output inflation. They continue to have margin pressure. Given how important the services sector is in the UK, the Bank of England needs to crack that.”
However, other investment managers take a much more benign view on the inflation outlook. James Thomson, manager of the Rathbone Global Opportunities fund, for example, says: “Everywhere I see it, inflation is coming down: commodity and logistics prices, for example, with the price of a 40ft container now down over 80% since the peak. When we look at consumer goods, a recent survey looking at companies’ plans to raise prices showed that this has rolled over very sharply. The idea that these companies are going to be raising prices is probably over.
“This is starting to be borne out in the things that the companies are saying. The chief executive of Walmart, for example, has said we should expect a period of deflation to come – in eggs, dairy, seafood, chicken, prices are dropping. It’s not just the rate of increase coming down. Disinflationary forces are creeping in.”
In the US, persistently high prices for ‘shelter’ have been controversial: central banks argue that there is no disinflation in shelter and that shows inflation is still persistent. Lindsay James, investment strategist at Quilter Investors, says: “Shelter inflation, which constitutes one of the largest components of US CPI, remained stubbornly high, rising 0.3% month on month. As a result, the path back down to target is going to be a long and arduous one.”
However, Thomson points out that the US has a peculiar way of measuring property prices, measuring something called the ‘owners’ equivalent rent’. This is a lagging figure, similar to the Land Registry in the UK, and it can take months for changes to appear. “They’re looking at stale data,” he says: “Why not look at a real time indicator like Zillow? That has rolled over very sharply. That is a leading indicator for the official data. Everything we see shows that the inflation beast is really starting to be tamed, including wages and salaries.”
Low growth, low inflation?
BlackRock’s Investment Institute presents yet another interpretation of the inflation data. It says: “The current market narrative: inflation is falling while growth is holding up. We agree with the first part – for now. We see core inflation hitting the Fed’s 2% target in the second half of 2024. The problem: inflation is falling because rapid rate rises to combat it have pushed the US growth trend below pre-Covid levels. We think more of the same is needed to keep inflation down as price pressures resume amid slowing labour force growth and geopolitical shocks.
“Markets appear to miss this bigger picture, and we see more volatility ahead as they swing between hopes for a “soft landing” and fears about higher rates and recession.”
Inflation appears to be falling, and any feared revival from rising energy prices has not yet emerged. This could provide consumers with a real boost in the year ahead, and if interest rate cuts emerge, markets could power ahead. Yet inflation retains the power to surprise in either direction. It is a complex landscape for investors and one in which binary bets come with high risks.