Every day seems to bring new headlines about the imminent return of inflation, but does the data reflect statistical swings in the pendulum or is this the beginning of a renewed trend?
Our firm view is that we will remain in a low-interest-rates-for-longer environment. While there will undoubtedly be a spike in growth and inflation once economies reopen, we believe this will mostly be due to low base effects and some temporary supply bottlenecks, and that these pressures will fade away after one or two quarters at most. In the short term, inflationary pressures will fluctuate but as investors who seek to balance risk and reward, we look to longer term trends. Structural inflation everywhere is being kept in check by the combined drivers of too much debt, ‘zombification’ of the corporate sector, ageing demographics, and disruption from globalisation, technology, and low-cost labour.
The good news is that the success of the vaccine rollout in developed markets has created a level of justified optimism. What remains harder to determine is whether the incredible valuations of both corporate credit and equity can be sustained if central bank support were to be removed. While it seems that central banks don’t want to rock the boat for now (we don’t expect any rate rises in the US for years, in fact), the underlying structural issues justify caution.
Growth is hard to generate in a highly indebted world
The eye-watering amount of global debt is central to why we believe the uptick in inflation is transitory rather than structural. Global debt levels climbed $40 trillion over the last 12 months alone. In total, the world is sitting on a $280 trillion debt pile, according to the IMF1. This is 3.2 times more than global GDP which stands at $87.5 trillion. Typically, when government debt-to-GDP reaches 50-60% this starts to have a deleterious effect on growth and therefore eventually acts as a drag on inflationary pressures.
Figure 1 shows how this is reflected in the falling neutral rate of interest in the US, where government debt is around 130% of GDP. The Euro area, Japan and China have even higher debt levels than the US, which is why we think the US will continue to outperform other major economic zones in terms of economic growth.