Deglobalisation Deglobalisation Deglobalisation

Deglobalisation will accelerate and impact inflation

PG
Peter Garnry

Head of Equity Strategy

Summary:  The war in Ukraine and the issues over Taiwan will drive deglobalisation and self-reliance systems across the global economy which will likely add to inflation longer term. This is an important trend to understand because it will impact interest rates and equity valuations. We put deglobalisation in the context of Mester's comments yesterday that inflation may not have peaked and we also criticize the core inflation paradigm.


The pendulum swings back

US House Speaker Nancy Pelosi’s visit to Taiwan will accelerate deglobalization in the years to come causing a huge adjustment to the global economy. Immediately after the visit China forced CATL to halt its $5bn battery plant in North America which was supposed to supply Tesla and Ford in their EV push. In consumer electronic, Motorola has pulled the launch of two products in the developed world and China has halted export of natural sand to Taiwan which is a key ingredient for semiconductor manufacturing. These moves show that China is retaliating and it wants to impact the US where it hurts. Besides Taiwan the moves could also be seen as payback for the recently passed US CHIPS Act which is set to build up US domestic semiconductor manufacturing and constrain South Korean and Taiwanese manufacturer to expand production in China.

China’s self-reliance policy is part of the current five-year plan and is a response to the trade war with the US. In many ways the self-reliance ecosystem through the Silk and Road programme was already in motion but now it was formulated into the five-year plan. The US CHIPS Act is a self-reliance policy of the US and Europe’s energy independence from Russia after the war in Ukraine is a self-reliance policy. The issues over Ukraine and Taiwan will most likely accelerate deglobalization and decouple a large part of the global economy and political system into two blocs.

Globalization was the major driver behind lower inflation in the developed world and thus deglobalization would likely mean higher inflation going forward as production shored back to Europe and the US is more expensive. In a deglobalization note from March this year we also highlighted Vietnam as winner in Asia from global supply chains being reconfigured. Self-reliance systems also means less just-in-time and more buffers which means more investments going forward and higher commodity prices as a result. Self-reliance systems also mean more renewable energy and thus this is a good theme for portfolios in the long-term.

Mester says inflation is still an issue

Staying with the inflation theme, Cleveland Fed President Loretta Mester said yesterday that inflation may not have peaked yet and there is more work for the Fed. Inflation has not moved down yet when observing m/m figures in the Fed’s preferred inflation measure, the PCE Core SA Index. As the chart below shows, the 6-month average core inflation rate is around 0.4% which is around 5% annualized inflation excluding energy and food. The Fed is likely looking for the 0.2% m/m over a sustained period before it scales back tightening. Another potential big policy mistake is for central banks to focus only on core inflation, because it assumes that energy and food are highly competitive global markets that adds zero inflation long-term but just volatility to inflation rates. Climate change and self-reliance mean that this assumption might be catastrophically wrong.

Mester’s comments yesterday lifted the entire US yield curve which surprisingly did little damage to equities with S&P 500 futures closing just below the 4,100 level and already today US equity futures are moving higher again suggesting momentum maybe has more leg. As we explained two days ago, we are still leaning statistically towards a pullback and Mester’s comments square with the market being too optimistic on the Fed Funds Rate in the first half of 2023.

PCE Core SA m/m | Source: Bloomberg
S&P 500 futures | Source: Bloomberg
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