Policy makers around the world might feel like patting themselves on the back for slaying the deflationary dragon in recent years – even Japan has enjoyed sustained price gains – but as Bloomberg’s Mark Cudmore warns “not so fast.“
U.S. tax cuts and a weakening dollar, along with prospective synchronous monetary-policy normalization, threaten to undermine the emergence of stable inflation rates.
The world has struggled for years against structural disinflationary pressures, in part thanks to technology and demographics. Neither of those trends has reversed.
The widespread belief now is that solid global growth will become the dominant driver of prices, with falling unemployment rates fueling expectations for the long-broken Phillips curve to kick back into gear.
That view overlooks the twin problems of low labor-force participation rates and the rise of automation.
Economists’ track record on anticipating inflation is poor. Price gains are still being consistently overestimated. Of the 12 national year-on-year CPI releases last week for which Bloomberg compiled consensus forecasts, seven missed estimates, and none beat them.
Look at the countries missing the forecasts, and you see diversity across both the economic and geographic spectrum: Singapore to South Africa, Mexico to New Zealand. The theme of subdued global inflation remains.
Yet the anticipation of faster inflation is now driving the narrative of monetary policy normalization.
This is a particular concern in the euro zone and Japan, where pressure for policy tightening is rising despite the fact that neither economy is set to get near target inflation rates on a sustainable basis even by next year.
Turning to the U.S., its tax cuts are helping boost bond yields — including a jump of more than 80 basis points for two-year Treasuries since September — in turn putting pressure on rates around the world, tightening monetary conditions.
A weakening dollar, meantime, adds to deflationary pressures outside the U.S. as other economies cope with currency appreciation.
Many commentators point to commodities as evidence of rising price pressures. But keep in mind, the weakening dollar means the gains are less impressive in other currencies — the Bloomberg Commodity Index remains toward the bottom end of multi-year ranges when measured in almost any currency besides the dollar.
Bottom line is that tax cuts and dollar weakness may well stoke U.S. inflation, but in the end prove a disinflationary impulse for the globe.
To be sure, this is all a tail risk rather than a base case. Many components can shift. But unless something changes radically in the next few months, deflation could be the real fear for markets in 2019.