Our Perspective on Stubbornly High Global Inflation Rates

There is a lot of inflation data out this week, and as you might have seen, it isn’t good. Grabbing most eyeballs on our shores, February’s Personal Consumption Expenditures (PCE) price index—the Fed’s preferred inflation measure—accelerated to 6.4% y/y, another multi-decade high.^[i] Meanwhile, preliminary March numbers in the eurozone suggest more pain is in store: the French Consumer Price Index (CPI) sped to 5.1% y/y, and Germany’s jumped to an eye-popping 7.2%.^[ii] Last week, Britain reported February CPI rose 5.5% y/y, up from 4.9% in January.^[iii] Another uptick seems likely when March data hit. The extended surge of fast inflation is a hardship for many and painful for all. Yet for stocks, “painful” often isn’t part of the calculus. Rather, are the ongoing disruptions forcing prices higher big enough to offset all the underappreciated positive drivers out there? We don’t think so.

Now, please note: Inflation is an increasingly partisan issue in many parts of the world. We favor no party nor any politician. Our comments on inflation are limited to the economics in question, viewed through a market-oriented lens. With that out of the way, we suspect it is worth noting inflation probably will peak higher—and stay elevated for longer—than we thought likely last summer. There is a simple reason for this: Russian “President” Vladimir Putin’s invasion of Ukraine, which rippled through oil, natural gas and other commodity markets, as well as complicating shipping routes. We have all felt this at the gas pump and when paying our electricity bills. Soon, fertilizer shortages may show up in food prices. So, too, might the potential shortages of wheat. Pricier petrochemical feedstocks will drive up costs for plastic and a range of consumer goods.

This is all happening at a time when the forces that drove prices higher throughout 2021 should be starting to wane. Last spring and summer—which might feel like an eternity ago—prices jumped off a depressed base as businesses reopened from lockdowns. Many businesses weren’t prepared for the sudden demand influx, sending prices higher throughout travel and leisure. Car prices also surged, in part because rental company activity was skewing the market. Those fast increases, with 2020’s lockdown-deflated prices as the denominator in the year-over-year calculation, were primarily responsible for inflation as 2021 progressed, with supply chain issues adding dislocations later in the year.

Yet these factors were poised to fade. The base effect would have left the math starting in April, raising the denominator. Logistical pressures appeared to be easing. It all pointed to prices rising more slowly off a higher base—making 2021’s faster inflation a one-off headache that eventually worked its way through the system. But then Putin invaded, replacing those fading inflationary forces with new supply-side price spikes. If oil and gas prices hover around today’s level, that points to inflation staying elevated for longer, simply due to inflation math, even if other prices are benign. We don’t mean to alarm you, but we think it is important to be realistic.

That is the bad news. The good news? There are a lot of positive forces out there right now to offset these headwinds. They aren’t getting much attention, because good news rarely does when stocks are in a correction (sharp, sentiment-fueled drop of -10% to -20%). As we detailed earlier this week, Purchasing Managers’ Indexes (PMIs) show European economies are still growing despite the fallout from Putin’s war. The EU is the most exposed major region, since it is dependent on Russian gas and most at risk of shortages and rationing. Yet even as surging oil drove French and German inflation higher, PMIs registered expansion. Why? Because the demand boost from COVID restrictions finally ending seemingly counterbalanced it. Several US states are experiencing a similar reopening wave, along with Japan. Not coincidentally, The Conference Board’s US Leading Economic Index (LEI) is on a long upswing.^[iv] So is eurozone LEI.^[v]

Yield curves globally are steepening. Yes, steepening! The gap between 3-month and 10-year yields, which is the portion of the curve that most translates to banks’ lending profit margins, is at its widest point since 2017—a great year for the US economy.^[vi] Eurozone nations’ curves have also overall steepened in the past few months.^[vii] It all points to more capital fueling more investment and growth. High prices incentivize investment all the more, as we are seeing in the oil industry right now. Tech hardware and industrial equipment are also big beneficiaries, attracting huge investment in Q4.

Paying higher prices at the pump and grocery store in the interim may be unpleasant for as long as they persist, likely a function of how long the war’s disruptions linger. But note: Stocks did fantastic in 2021 despite inflation accelerating to 40-year highs throughout the year. That isn’t all that unusual, as inflation isn’t inherently bearish. So take a deep breath and remember stocks have seen this movie before, and continued economic growth should help them weather the ongoing inflation storm.