Blackrock has come out with his latest note on macro perspectives and makes a compelling argument: inflation is largely being driven by supply shocks, not fiscal policy, and raising interest rates is not the solution.
This was largely caused by manufacturing shortages and a shift in consumer spending towards goods rather than services.
We’ve heard it all before, and it’s compelling. I think inflation will go away along with the virus and we’ll be right back to the post-financial crisis economy. That’s the best-case scenario.
Because if inflation continues and the Fed is forced to raise Fed funds to +4% levels, there will be a debt market bloodbath that will spill over into everything. Bonds are the biggest bubble in history and when the bubble bursts it will be catastrophic worldwide.
In any case, this will not be solved now.
However, what is happening is just as interesting.
It’s becoming increasingly clear to me that people feel inflation. That should be obvious when prices in the U.S. are up 7% year over year. What has changed is that higher prices are becoming more prevalent, especially for groceries and gas. Before. it was limited to things like used cars, and I think people could streamline that.
Now people are frustrated and angry about rising prices. They are looking for an outlet for this.
Of course they point to politicians. Biden is being skewered in the US for inflation, but as Blackrock argues, the fiscal side accounts for a small part of inflation and the cost of not providing pandemic support would have been prohibitive. In addition, Biden has not caused inflation in Germany, in Canada, in Brazil and almost everywhere in the world.
But people need an outlet. You need someone to blame.
Inflation has sowed dissatisfaction. People feel ripped off. At the grocery store, they take it out on cashiers, but that’s just the beginning. Despite all government spending and stock market gains, many people feel they are getting poorer. This is a dangerous cocktail.
As bad as it is in the developed world, it has to be an order of magnitude worse in the emerging world. There is no way people can afford the price increases. The Arab Spring began as a protest against food prices. The drama in Kazakhstan began this year with price hikes for propane and butane.
I don’t know where that ends, and I’m not heartened by the lack of confidence that finance and monetary officials are expressing on this. Anger scares them.
“When supply constraints are responsible for higher inflation at a time when the economy is not yet back to full capacity, one has a difficult choice to make: either live with higher inflation or destroy activity before full capacity is reached” , writes Blackrock.
“The main risk we see is that central banks will slam on the brakes if restrictions remain in place, believing that higher inflation could affect inflation expectations. This would be bad for bonds and stocks as interest rates rise to restrictive levels and slow growth. Some of that risk can be priced in at points – as in recent weeks – as markets adjust to this new macro landscape. However, if central banks hit the brakes, they are likely to find that the cost of doing so is too high, and be forced to reverse course. At points where this risk is priced in, yield curves tend to flatten or even invert.”