Who is right about inflation?
Chief Economist & Fund Manager
May CPI in China came in about 1.3%, below the average estimate of 1.6%. This was mostly due to weak pork prices. Please note the CPI Index in China is heavily geared towards food. The producer price index on the other hand rose by a whopping 9% Y/Y, mainly driven by oil, metals and chemicals.
Chinese PPI is a function of higher commodity prices, not due to internal factors. This means inflation is not exported outwards. So, what happens in China in CPI or PPI terms, stays in China. In other words, don’t expect China to be an exporter of inflation as many have suggested. Please note that for the last 30 years or so, China is a deflation exporter, not an inflation exporter.
Last Thursday headline CPI in the US rose 5% Y/Y, the fastest pace since 2008. Used car and truck prices were partially to blame, posting an almost 30% rise Y/Y.
It is the norm for economies to experience pent up demand when coming out of a recession. However, this time around we also have supply chain disruptions due to the pandemic, but also supply chain disruptions because of politics.
But a rise in commodity prices due to supply shortages and disruptions has always been temporary. This is the main reason why Central Banks insist inflation will be transitory.
But the question is, what does the market have to say about all the inflation talk? The market is taking the inflation talk with a big yawn. We have not seen a correction in equities, nor a huge rally in bonds. In fact, when US CPI figures was published last Thursday, the 10-year US bond rallied and yields fell below 1.5%, after rising to almost 1.75% several months ago.
So insofar as the market, the message from the bond market is that it is siding with the Fed, and so far, it is not worried about persistent rising inflation expectations.
Finally let us not forget that even if inflation persists for the next several quarters, the reasons why inflation has been low for a long time have not changed. And the two main reasons are demographics and technology innovation.
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