Monthly Macro Outlook : The transitory narrative continues to fall apart
Head of Macro Analysis
Summary: The economist consensus anticipates inflation will start falling from early next year. We disagree. We consider the market to be too complacent regarding upside risks to the inflation outlook. The great awakening of workers and the steady rent increase (for the United States) are two of the factors which are likely to maintain inflation uncomfortably high into 2022, in our view.
October CPI figures released earlier this week confirm that inflationary pressures may last longer than initially expected. Inflation reached levels which have not been seen for decades in the United Kingdom (+4.2% YoY), in the eurozone (+4.1% YoY) and in Canada (+4.7% YoY). In Canada, the jump in inflation is the strongest recorded in 18 years. For now, investors are confident. They believe the U.S. Federal Reserve and European Central Bank’s narrative that inflation will start to fall from early next year. This is far from certain, in our view. From supply chain bottlenecks to energy prices, everything suggests that inflationary pressures are far from over. Expect energy prices to continue increasing as temperatures will drop in Europe from next week onwards. This will weigh on November CPI data which will be released next month. The peak in inflation has not been reached. We fear investors are too complacent regarding upside risks to the inflation outlook.
Every economic theory says inflation will be above 2% next year :
· The Phillips curve is alive and well : workers are demanding higher salaries, amongst other advantages and their expectations are rising.
· Monetarism : the global economy is characterized by large deposits, desire to spend and to convert cash into real assets.
· Commitment approach : the U.S. Federal Reserve (Fed) and the European Central bank (ECB) have a dovish bias. This is confirmed by their new inflation strategy (symmetric 2% inflation target over the medium term for the ECB and inflation of 2% over the longer run for the Fed).
· Fiscal approach : high public debt and fiscal dominance (central banks need to remain dominant market players in the bond market to avoid a sharp increase in interest rates).
· Supply-side approach : supply bottlenecks due to the zero Covid policy in China and central banks’ trade off higher inflation for a speedier economic recovery (the ECB especially).
· Green transition : this is basically a tax on consumers.
What has changed ?
The wage-price spiral has started. In countries where the labor market is tight, workers are asking for higher salaries. In the United States, the manufacturer John Deere increased salaries significantly : +10% this year and +5% in 2023 and in 2025. It also agreed to a 3% bonus on even years to all employees, for instance. But this is happening in countries where the unemployment rate is high too. In France, the unemployment rate is falling. But it remains comparatively elevated at 7.6% in the third quarter. Earlier this week, the French Minister of Economy, Bruno Le Maire, called for higher salaries in the hospitality industry. A survey by the public investment bank BPI and the pro-business institute Rexecode show that 26% of small and medium companies are forced to propose higher salaries to find employees. Those which are reluctant choose to reduce business activity. The pandemic has fueled a great awakening of workers, in our view. They are demanding more : better job conditions, higher wages, more flexibility and purpose from work. This is more noticeable in countries facing labor shortage. But it is also visible in all the other developed economies to a variable extent.
U.S. steady rent increase is a game-changer. Until now, supply bottlenecks were the main driver behind the jump in prices. Now, housing costs (which represent about a third of living cost) and prices in the service sector are accelerating too. The rental market is tight, with low vacancy rates and a limited stock of available rentals. Expect rents to move upward in the coming months. According to official figures, owner’s equivalent rent, a measure of what homeowners believe their properties would rent for, rose 3.1% YoY in October. This certainly underestimates the real evolution of rents. Based on data reported by real estate agents at national level, the increase is between 7% and 15% YoY. All in all, this reinforces the view that inflationary pressures are proving more persistent than expected.
The moment of truth : Expect investors not to question much the official narrative that inflation is transitory, for now. But if inflation does not decrease from 2022 onwards, investors will have to adjust their portfolio to an environment of more persistent inflation than initially anticipated. This may lead to market turmoil. In the interim, enjoy the Santa Claus rally which has started very early this year.
The new inflation regime in the United States