There also appears to be no uptick in gauges of money velocity, indicating cash balances will remain high and consumers’ expectations for inflation are within reason (ie they are not rushing out to spend cash they consider depreciating in real terms). Low velocity also helps blunt the inflationary impact of rising money supply.
Finally, perhaps the single most important indicator of structural inflation is spiralling wage growth, which leads companies to raise prices, thus leading workers to demand higher wages (as occurred in the 1970s). The OECD’s labour compensation per employed person hit 5 per cent in the first quarter of 2021, very high, historically speaking. However, it appears a peak may have been hit, or at the very least, a deceleration: Q2 and Q3 registered at 4.5 per cent and 4.4 per cent, though admittedly there are regional idiosyncrasies.
Labour supply is likely to become more elastic over 2022 as ongoing crisis-era benefits dry up and Covid-related restrictions abate. Of course, this could prove far too optimistic, but we believe our optimism is well founded.
Historically speaking
With price pressures likely to dissipate naturally over the course of the year, policymakers should have sufficient breathing room in the short term to continue a gradual yet non-panicked escalation of their rate hiking cycle. Indeed, the latest escalations in the Russia/Ukraine conflict should provide central banks with a get-out-of-jail card on the most aggressive policy actions – there is less immediate need to fight inflation amplified by exogenous factors (ie energy prices) while jeopardising a fragile economic recovery further unsettled by geopolitical tensions. Either way, the market expects US 10-year Treasury yields to top at around 2.5 per cent over the next few years.
This is markedly higher compared to the recent period following the financial crisis of 2007, however decidedly low by historical standards – indeed, in the five decades preceding the crisis, yields never dropped below 3.5 per cent.
From a technical perspective, higher yields will dampen demand as financing for anything from iPhones to real estate becomes comparatively more expensive. It will also put pressure on discount rates, meaning that profits in the far future appear less attractive today – an issue that is particularly alarming for growth stocks: in the year to date, the Russell 1000 Growth index has underperformed its value counterpart by about 11 per cent.
However, given the respective trajectories of rates and inflation, real yields will likely remain negative for the time being and monetary policy highly accommodative for the foreseeable future, supporting risk assets. In fact, rates at those levels are a reliable signal for a strong and robust economy, laying the groundworks for companies to thrive.
