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Tuesday, June 6, 2017
The World’s $100 Trillion Question: Why Is Inflation So Low?
Central bankers and investors are grappling with a $100 trillion question: why consumer price inflation remains so low in most parts of the world even as economic growth quickens.
Compounding the riddle, question marks are now emerging over the one part of the global inflation picture that had been moving higher -- producer prices. That’s because two engines of that turnaround -- China’s resurgent factories and prospects for tax-cut fueled stimulus under President Donald Trump -- are showing signs of fading.
Which way the inflation mystery unravels is crucial for the global monetary policy outlook and the world’s $100 trillion bond market. And as with any puzzle, there are rival camps out there in the eco-sphere, with Michael Shaoul, chief executive officer at Marketfield Asset Management in New York, among the PPI-reflation believers.
“This remains an obviously reflationary period for the global economy, with the broadest rise in input cost seen since the global V-shaped recovery hit the skids in 2011,” Shaoul wrote in a recent email. He charts producer prices in China, the U.S., Germany and South Korea -- which make up more than 50 percent of traded goods -- to show the trend.
While that chart makes compelling viewing, reflation skeptics had their case bolstered by China’s May manufacturing purchasing managers’ indexes. The government’s PMI reading showed the sub components for both input and output prices dropped sharply even as the headline reading held steady. Caixin Media and Markit Economic’s private report fell back into contractionary territory for the first time since last June.
“While China is crucial to global inflation trends, there is little to suggest that China will be a major driver of global reflation in the coming 12 months,” said Louis Kuijs, head of Asia economics at Oxford Economics in Hong Kong. “We expect China’s real estate construction to slow down in the second half of 2017. Combined with remaining excess capacity in China’s heavy industry, this implies reduced support to commodity prices, domestically and internationally.”
Bloomberg Intelligence Chief Asia Economist Tom Orlik was even more definitive: “China’s factory reflation story is over,” he wrote after the Caixin report was released on June 1.
That leaves the reflationary ball back in Trump’s court. The U.S. president has promised to plow ahead with hundreds of billions of dollars in spending on new roads and bridges, funded by the public and private sectors, along with pledges for far reaching tax reforms.
“What happens next in the U.S. has become critical,” economists at Societe Generale wrote in a recent note. Their verdict: “Trumpflation” will be “insufficient to offset fading Xiflation” -- a reference to Chinese President Xi Jinping.
Markets too seem to share that view, with bets on accelerating inflation late last year and early in 2017 now unwinding.
At the same time, upstream pressures continue to build in the U.S. Producer prices there rose a more than forecast 2.5 percent in April from a year earlier.
Yet, American consumer prices are showing few signs of following the pick up in PPI. The Federal Reserve’s preferred price measure rose 1.7 percent in April from a year ago, down from 1.9 percent in March and 2.1 percent in February. Core inflation -- which strips out volatile oil and food costs -- also slowed to the weakest annual pace since 2015.
In the euro zone, while producer prices rose 4.3 percent from a year earlier in May, that pressure has yet to flow through to consumer inflation either. Euro-area inflation decelerated to 1.4 percent in May -- the weakest reading this year -- from 1.9 percent a month earlier.
Those readings will support European Central Bank President Mario Draghi’s argument that it’s too early to commit to an exit from monetary stimulus.
Reflationists argue that trade is improving with the global economy and PPI pressures will keep building. With all the liquidity sloshing around after years of central bank support, it’s just a matter of time until wages and consumer prices head north as well, they say. Problem is, the latest data from around the world just aren’t following that script.
“In many places, upside CPI surprises have turned into downside surprises, and central bankers no longer seem as keen to tighten the screws,” said Frederic Neumann, co-head of Asian economic research at HSBC Holdings Plc in Hong Kong. “With China’s construction engine likely to ease back over the coming months, the global reflation risks running out of runway.”