Immaculate disinflation: Is that possible?

Immaculate disinflation: Is that possible?
Immaculate disinflation: Is that possible?
Share post:

Can price stability, i.e. inflation of 2%, be achieved without a recession? The historical relationships between economic indicators answer this question in the negative. But the further decline in US inflation for the month of June has raised expectations for this favorable scenario.

Inflation falls faster than expected

The report on consumer price inflation in the US for the month of June has pointed to a larger-than-expected decline across the board. The overall figure rose 3.0% on an annual basis, down from 4.0% the previous month. The core rate, i.e. excluding the volatile components food and energy, rose 4.8% on an annual basis, which was also significantly below the previous month’s value of 5.3%.

Source: Refinitiv Datastream; Note: Past performance is not a reliable indicator for future performance.

Other indicators also point to a downward trend in price increases. he components with a high persistence of inflation (sticky CPI) increased by 0.2% in the month of June (high: 0.7% in September 2022). The measure preferred by Federal Reserve Chairman Powell, inflation in the services sector excluding food, energy and rents, was actually unchanged month-on-month in June (high: 0.8% in April 2022).

…on a broad basis

In addition, other inflation reports were also favorable. Producer prices showed an increase in the core rate of only 2.4% on an annual basis and US import prices continued to decline to -6.1% year-on-year.

According to the University of Michigan’s flash estimate, consumer inflation expectations for the coming twelve months rose slightly in July (to 3.4% from 3.3%), but the trend is clearly pointing downward. Moreover, a figure of 2.9% would already be a level consistent with 2% inflation. Of course, this is only if the historical relationship between inflation expectations and actual inflation continues to hold.

Furthermore, a report on wage growth by the Federal Reserve Bank of Atlanta showed a further decline. The so-called Wage Growth Tracker fell to 5.6% year-over-year in June (high: 6.7% in June 2022). That level is not yet consistent with 2% consumer price inflation. That’s because productivity growth is low. But the trend in wage inflation is clearly pointing down.

Positive real wages

Classically, the development of wages lags behind that of inflation. Wage growth is thus inconsistent with the definition of price stability, but falling inflation usually means falling wage inflation with a time lag. In the meantime, rising inflation-adjusted wages support personal income and thus private consumption. Indeed, real average hourly wages rose 1.2% year over year in June. This measure had been negative since the second quarter of 2021.

Recession probability down

The falling inflation trend reduces the probability of recession because there is less pressure on the central bank to step up its restrictive policy even further. However, the favorable inflation trend can quickly be cancelled out by future poor inflation reports. Moreover, it is unclear at which level inflation will settle and whether inflation uncertainty or inflation volatility will then remain high or fall.

A key interest rate hike of 0.25 percentage point at the Fed’s upcoming rate meeting remains very likely. It is also likely that the maintenance of a restrictive policy will be reaffirmed, meaning that indications of key interest rate cuts are not to be expected. However, it is also likely that the central bank will signal a longer pause in the rate hike cycle in order to better assess the effects of previous key rate hikes.

Conclusion: Favorable environment for financial markets

The inflation reports in the USA are clearly favorable for the financial markets. First, the main enemy of bonds, high inflation, looks less threatening. Second, the same is true for the main enemy of equities, a recession.

However, history urges caution. In the past, a central bank-induced decline in inflation has often been accompanied by a recession. Therefore, caution is still warranted.  A flawless inflation decline (without a recession) would be too good to be true.

For a glossary of technical terms, please visit this link: Fund Glossary | Erste Asset Management

Legal note:

Prognoses are no reliable indicator for future performance.

RESPOND TO THE ARTICLE

Legal disclaimer

This document is an advertisement. Unless indicated otherwise, source: Erste Asset Management GmbH. Our languages of communication are German and English.

The prospectus for UCITS (including any amendments) is published in accordance with the provisions of the InvFG 2011 in the currently amended version. Information for Investors pursuant to § 21 AIFMG is prepared for the alternative investment funds (AIF) administered by Erste Asset Management GmbH pursuant to the provisions of the AIFMG in connection with the InvFG 2011. The fund prospectus, Information for Investors pursuant to § 21 AIFMG, and the Key Information Document can be viewed in their latest versions at the web site www.erste-am.com within the section mandatory publications or obtained in their latest versions free of charge from the domicile of the management company and the domicile of the custodian bank. The exact date of the most recent publication of the fund prospectus, the languages in which the Key Information Document is available, and any additional locations where the documents can be obtained can be viewed on the web site www.erste-am.com. A summary of investor rights is available in German and English on the website www.erste-am.com/investor-rights as well as at the domicile of the management company.

The management company can decide to revoke the arrangements it has made for the distribution of unit certificates abroad, taking into account the regulatory requirements.

Detailed information on the risks potentially associated with the investment can be found in the fund prospectus or Information for investors pursuant to § 21 AIFMG of the respective fund. If the fund currency is a currency other than the investor's home currency, changes in the corresponding exchange rate may have a positive or negative impact on the value of his investment and the amount of the costs incurred in the fund - converted into his home currency.

This document serves as additional information for our investors and is based on the knowledge of the staff responsible for preparing it at the time of preparation. Our analyses and conclusions are general in nature and do not take into account the individual needs of our investors in terms of earnings, taxation, and risk appetite. Past performance is not a reliable indicator of the future performance of a fund.

Leave a comment Required fields are marked with *

Your email address will not be published. Required fields are marked *