We are certainly living in an unusual world, as global GDP has gradually picked up through 2014 but this acceleration in activity has, as yet, been unaccompanied by a rise in inflationary pressures or commodity prices. Today I will examine why this is and discuss our future expectations for inflation. Inflation gauges around the globe are currently mostly very weak. Those of you who have the same misfortune as I of sitting on Southeastern Trains or using Southern Water will dispute this, but the lack of inflationary pressures is a fact.
The obvious culprit for generating inflation over the last decade has been commodity prices, especially due to the increasing ‘consumerisation’ of the emerging market economies. This year commodity prices have mostly been very well behaved and the oil price, despite rising geo-political temperatures, has fallen. There are a number of reasons for this.
Firstly, while economic momentum has built, the world is not spinning at such a velocity to drag oil prices higher. In addition, in the West we are becoming greener and our oil intensity has fallen.
Performance of index in 2014
Source: FE Analytics
In China, despite general increased usage, there are sensible government initiatives to curb pollution and their focus away from infrastructure has blunted the dragon's appetite for all resources.
Another major factor suppressing the oil price (and other commodities) is the excess supply currently enjoyed, particularly in the US, where shale production is now a decisive factor.
As we look forward, we struggle to envisage a demand driven influence on commodity prices in the short term. Longer term is a totally different story and worthy of a blog to itself. (We at Psigma are particularly worried over long-term imbalances in foodstuffs and fertilisers).
So the good news is that we shouldn't be fearing the price at the petrol pump or the opening of our latest lecky bills (or something like that).
The bad news is that our bosses are miserable gits (although mine is very nice). Wage settlements across the developed world are meagre, particularly in our fair Kingdom where wage growth is basically nothing. Mrs Becket had better buy just the one Mulberry bag this Christmas.
In the US and Europe headline wage inflation is also contained, allowing the central banks breathing space with monetary policy. However, if one scratches beneath the surface of the data, there are clear inflationary pressures building in certain sectors, such as construction and high end manufacturing (wealth management is sadly over-supplied).
We feel strongly that the Fed and the Bank of England are missing the point when they look at the unemployment situation and wider wage inflation, as they mistakenly think that the long-term unemployment in the former industrial heartlands of the UK, US and other developed economies are coming back.
It seems unlikely to us that they will and this current distortion to the employment situation is creating an illusory disinflation picture.
As many potential new employees have become structurally unemployable, we would expect their influence on wages to diminish and we could start to see greatly improved wage settlements in the coming quarters, which could both spook central bankers and impact upon corporate profits.
Ultimately central bankers should embrace this as it would help to break the secular stagnation in the developed world, although it would leave some unhappy souls behind.
They key link to our long-term fears of inflation is monetary policy and the distorting influence of all the cheap money that has been force-fed in to the financial system over the last few years.
We are yet to know the true result and possible side-effects of the greatest financial experiment in history, but all past examples of such largesse have created issues; chief amongst them is inflation.
The reason why quantitative easing has failed to stoke the inflationary fires thus far is that there has been a failure in the lending mechanisms and a mismatch in lending intentions. In short, those who want to borrow and not those that banks wish to lend to and vice versa. If at some point this situation changes then one could start to see a decisive move higher in lending and, subsequently, inflation.
The loose money will end up somewhere and it could well lead to a mess. I wouldn't trust the central bankers to be able to remove excess liquidity ‘just in time’ In fact, I’m pretty sure they’ll mess it up.
So it makes sense to persist with an inflation-proofing strategy, despite the recent meagre rates of inflation. In fact, given the collapse in breakeven rates of inflation-linked bonds and the fall in commodity prices, inflation-proofing can currently be achieved at reasonable prices.
If we are right and the great disinflation that we are experiencing will eventually give way to higher rates of inflation, then taking measures to protect your assets now could be vital to your future wealth.
Tom Becket (pictured top of page one) is chief investment officer at Psigma. The views expressed here are his own.
