Do not underestimate inflation and overestimate the risk of stagflation

Recently, the hottest topic touching investors’ sensitivities has been global (especially U.S.) inflation, with oil prices soaring, U.S. bond interest rates climbing rapidly and U.S. stocks fluctuating sharply, all of which highlight investors’ deep unease with the current economic environment.

Previously, when the U.S. Consumer Price Index surged near 5% year-over-year in May, Fed officials came out shouting that the inflation phenomenon was temporary, but the price index continued to be high in June, July and August, rising 5.3% to 5.4% year-over-year, indicating that the inflation problem was not as expected by Fed officials, suggesting that they had previously underestimated the risk of inflation.

During this period, the U.S. 10-year bond yield, which is psychologically related to inflation expectations, also fell in line with the expectations of Fed officials, slipping from a peak near 1.74% at the end of March to 1.17% at one point in early August. Indicating that bond market participants agree with officials who say inflation is temporary.

However, with the recent spike in natural gas prices and oil prices hitting a seven-year high, many key raw materials remain in short supply and Fed officials are beginning to change their tune, saying that inflation may remain in place for a longer period of time.

Some pessimistic experts believe that the U.S. non-farm payrolls report has been worse than expected for two consecutive months, with an increase of 235,000 in August and 194,000 in September, far below the expected 500,000 near, showing that the recovery of the job market has turned worse, coupled with rising prices, so advocating that the current inflation problem may evolve into catastrophic stagnant inflation.

In the author’s view, the risk of stagflation may have been overestimated again. The main argument is that the factors pushing inflation up are the economic recovery and the supply chain bruising caused during the epidemic. If the momentum of the economic recovery is now weakening and the epidemic is gradually easing, it is really impossible to see how inflation will deteriorate further. In other words, the worst case scenario should not be stagflation, but a simultaneous slowdown in inflation and economic recovery. A better scenario would be one in which the economy cools little, but the inflation temperature cools significantly.

So-called stagflation , there must be an unexpected stimulus that cannot be objectively managed or controlled for a short period of time, such as the oil crisis of the 1970s. Nowadays, many people associate the big rise in oil prices with the 1970s, but in essence, this cannot be easily equated. The biggest difference between the current economic model and the 1970s is that people’s reliance on oil has been significantly reduced, and many alternative energy sources have been emerging, coupled with technological advances that have led to the efficiency of transactions, all of these factors have reduced the correlation between oil prices and prices.

Morgan Stanley in its latest report predicts that the U.S. unemployment rate will continue to decline next year, soaring inflation will cool, stagnant inflation is a weak basis for the argument, the market has mostly underestimated the growth in demand. The author feels the same way.

The general estimate is that U.S. GDP could grow by about 5.7% to 6% in 2021 and cool to near 4% in 2022. On the inflation side, the Federal Reserve predicts that consumer prices will increase by more than 4% year-on-year in 2021, and will fall to 2% in 2022. Some professional bodies expect U.S. prices to fall to near 2.6% year-over-year in 2022. If the objective forecast above is correct, the U.S. GDP growth rate in 2022 will still be greater than the price increase and definitely not a stagnant inflationary environment.

On Wednesday (13th), the U.S. price report for September will be released, and the market estimates that the Consumer Price Index will increase by 5.3% year-over-year, the same rate of increase as in August. If the actual figure does not exceed 5.3%, the market’s stagflation alarm will temporarily dissolve and risk assets may see a larger rebound; if the figure exceeds 5.5%, hitting a new high again, financial markets may once again set off waves, but still cannot assert that a stagflationary environment has emerged and needs to be observed for a few more months.

The U.S. 10-year bond yield had risen as high as 1.628% on Tuesday, hitting a peak since late May, but closed at 1.572%, falling below the 1.6% mark, showing that bond market traders did not continue to chase short before the release of the U.S. price report. Previously, Wall Street economists mostly predicted that the yield would rise above 1.6% by the end of the year, and now that it has been reached ahead of schedule, will it continue to surge higher to 1.8% or 2% next? Will depend on whether the bond market is expected to increase the risk of stagflation.

I thought that most financial market participants would underestimate or amplify the risk of expected events, and after the end of March the bond market underestimated the risk of U.S. inflation, with the 10-year bond yield falling from 1.74% to 1.17%. Now, many experts may also amplify the psychology of stagflation expectations, making the recent financial market volatility increased, and Wednesday’s price report will be a key test point, investors may wish to wait patiently for the results to come out.