Persisting Inflation: 3 Key Causes Explored
In a rapidly evolving economic landscape, several factors are contributing to sustained price pressure and inflation persistence beyond the initial short-term effects of the global reopening and excess liquidity in the market.
One of the key drivers is the collective behaviour pattern among companies, with many worldwide, including in various sectors, displaying a new willingness to raise their prices at the expense of investments. This trend is likely to lead to tighter capacities and greater pricing power for industry leaders.
China, a significant player in the global economy, has been undergoing significant changes. The political will in the country to implement supply-side reforms in the bloated state-owned sector is a response to the high debt and overcapacity in the economic system, which was exacerbated by excessive countercyclical measures after the global financial crisis in 2008.
The reduced excessive exports at extremely competitive prices by China has played a significant role in the increased global price discipline. China's export of deflation to Western industrialized countries has waned, leading to increased prices ex-factory.
Meanwhile, economic uncertainty is causing many companies that have survived the crisis to hesitate in making investments that increase their fixed costs. This hesitation, combined with China's role as a net importer of raw and basic materials, contributes to global price pressure.
In the current situation, housing prices are rising sharply in Asia, the UK, and the U.S., due to the imbalance in demand and supply of housing. The trend of baby boomers no longer downsizing is counteracting the demand for housing, creating a structural imbalance that was not anticipated.
On the other hand, many millennials in various regions, including the U.S., are reaching an age where they are starting families and considering homeownership, leading to stable demand for residential real estate post-pandemic.
Investors face several challenges, including predicting the magnitude of price pressure and central banks' reactions, the timing of normalization of monetary policy in the U.S., and the correlation fluctuations between bond and equity markets. Higher inflation in the past has led to lower real yields, and it is expected to happen again, given the challenging outlook.
In response to these trends, it is recommended for investors to favor growth and yield segments of the market, with cautious duration positioning. The tug-of-war between high price pressure and long-term factors of disinflation will continue and resolve slowly.
Sources: [1] IMF World Economic Outlook Update, July 2021 [2] Federal Reserve Bank of San Francisco, Economic Letter, August 2021 [3] Bank of England, Inflation Report, August 2021
- The trend of companies increasing their prices, instead of investing, could significantly impact economic and social policy, possibly necessitating changes in finance strategies to mitigate tighter capacities and increased pricing power for industry leaders.
- With global price pressure caused by economic uncertainty and China's role as a net importer of raw materials, investors might find it challenging to predict the magnitude of price pressure and central banks' reactions, making careful considerations in their investing strategies, favoring growth and yield segments of the market with cautious duration positioning.
