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  • William Bourne

Annual Inflation Indicators Survey | Linchpin



This is Linchpin’s twelfth annual update on the long-term outlook for inflation, in which we monitor a range of inflation indicators.  Last year, we expected inflation to fall from the late 2022 peaks but thought it would settle at 3 to 5% with Japan a possible outlier on the upside.  Looking forward from here, it appears that central banks have regained some measure of control for now, but the longer-term indicators look ominous. 

  

William Bourne   31st December 2023 

 

LINCHPIN INFLATION INDICATORS 

Indicator 

Change Over 12m 

Category 

2019 

2020 

2021 

2022 

2023 

2024 

Real and nominal long-term bond yields 

Yields normalised at 4 to 5% 

Market 

Neutral 

Deflation 

Deflation 

Deflation 

Inflation 

Neutral 

Implied inflation five years out 

Fallen since last year 

Market 

Neutral 

Neutral 

Neutral 

Neutral 

Neutral 

Neutral 

Interest rates  

Risen further but may have peaked 

Market 

Deflation 

Deflation 

Deflation 

Deflation 

Deflation 

Neutral 

Gold price 

Reached new high above £2,000 per oz 

Market 

Neutral 

Inflation 

Inflation 

Inflation 

Inflation 

Inflation 

Commodity prices 

Surge in energy and food has fallen back 

Supply 

Inflation 

Neutral 

Inflation 

Inflation 

Neutral 

Neutral 

Cost pressures 

Labour costs rising sharply post COVID 

Supply 

Inflation 

Inflation 

Inflation 

Inflation 

Inflation 

Inflation 

Overcapacity 

Capacity becoming redundant as world changes? 

Supply 

Neutral 

Deflation 

Neutral 

Inflation 

Inflation 

Inflation 

Higher growth 

Global growth weak 

Demand 

Deflation 

Deflation 

Deflation 

Deflation 

Deflation 

Deflation 

Leverage 

Leverage no longer available 

Demand 

Inflation 

Inflation 

Inflation 

Inflation 

Deflation 

Deflation 

New sources of demand  

Governments 

Demand 

Inflation 

Inflation 

Inflation 

Neutral 

Neutral 

Inflation 

Liquidity creation 

Back to QE, albeit covert rather than overt 

Policy action  

Deflation 

Neutral 

Inflation 

Neutral 

Deflation 

Neutral 

Monetary debasement 

Almost inevitable in West 

Policy action 

Inflation 

Inflation 

Inflation 

Inflation 

Inflation 

Inflation 

 

The dial has moved back towards inflation 


Central bank policy is succeeding in bringing inflation down, at least on its own terms.  Current inflation dots to November 2023 are at 3.1% (U.S.), 3.1% (Euro), 3.9% (Japan), and 3.9% (U.K.).  The Personal Consumption Expenditure deflator, an indicator which the Fed focuses on, stands even lower at 2.6%. 


There are some significant outliers, most notably China, where the headline CPI figure was -0.5% and food price inflation -4.2%.  This is despite a more accommodating monetary policy than any other bank.  Surprisingly, Japan is also an outlier, not because the overall inflation rate is very different, but it covers some contrasting trends:  56% of Japan’s CPI basket is rising at more than 10%, while utilities inflation is -22% over the last 12 months.  Japan’s monetary policy is also out of line with other major central banks.  


Lower commodity prices (on the supply side) and higher interest rates making borrowing more expensive (on the demand side) must also have been factors in the 2023 decline in inflation.  For example, wheat prices halved from their 2022 peaks, though they have since risen again.   


Looking forward, however, the net score from our 12 indicators has moved back towards inflation at +3 (+1 in 2022), with five indicators pointing to inflation, five to neutral, and two to deflation.  As we commented last year in reverse, this may seem counter-intuitive, but reflects the longer-term threats.      


Monetary debasement has pointed to inflation throughout the twelve years we have monitored these indicators, and in our view is now the chief threat.  Behind that is the bind which central banks have got themselves into.  The U.S. Fed needs to finance or refinance around $11 trillion over the next 15 months.  The laws of supply and demand would lead one to expect much higher bond yields as a result.  However, the cost of servicing this debt, already 10% of total expenditure in the U.K. and 16% in the U.S.,* would become politically impossible. 


The Fed. and other banks have therefore resorted to using shorter-term paper to pay Government’s bills, which is effectively renewed QE.  Instead of issuing bonds and buying them back using short-term paper, they are simply issuing short-term paper.  In practice we are off to the ‘magic money-tree’ again, which is why we view monetary debasement as by far the greatest threat in the longer term. 

 

Supply-side inflation pressures are balanced 


Our market side indicators are broadly pointing neutrally.  Interest rates and bond yields are at levels which could be considered normal in the context of history.  Implied inflation rates continue to fall in the U.S. and the ten-year rate is now at 2.0%.  In contrast the U.K. equivalent is at 3.4%, or significantly higher.  This measure is not predictive, but does indicate the level of future inflation which bond markets today expect.    


The gold price, which made a new high just above US$2,000 per ounce in 2023, is still pointing at inflation.  Gold’s role as the ultimate store of value may have been partially taken over by digital equivalents outside the central banks’ control, such as cryptocurrencies, but it is still signalling a higher risk of monetary debasement.  


Supply side pressures are more balanced than they were last year when they mainly pointed to inflation.  Since then, while the bubble in (many) commodity prices has deflated, food and energy both look vulnerable to more supply side disruption.  On the other side labour cost rises in the west show few signs of abating, with shortages in many countries.  One consequence is that labour is likely to increase its share of national wealth.   


The output gap is a theoretical calculation at best, as it depends on the estimate of potential sustainable GDP growth.  So it is no surprise that estimates in the U.S. range from 3% (Nowcasting) to 11% (Y-charts).  It seems fair to say that the U.S. is running ‘hot’ with limited capacity, but in contrast, as China’s growth has been slow to recover from the COVID lockdowns, it may well provide a counterbalancing disinflationary impulse.  


Governments will drive new spending 


Demand indicators, as last year, lean towards disinflation:  Private demand (in the west) is suffering from higher borrowing costs and higher taxation to pay for Government spending during the COVID lockdowns.  Perhaps the largest shift in the past twelve months has been the willingness of governments to embrace fiscal expansion.  In some cases this is military necessity as the world becomes more confrontational; in others it is a sign of political weakness in the face of increasing health and other demands.  The U.S. qualifies on both counts. 


In theory government spending is self-limiting as the cost of borrowing (i.e. bond yields) becomes prohibitive.  However, if a government resorts to printing money, whether literally or through QE, then that may suppress bond yields.  Hence the CBO2** forecast that U.S. borrowing will be 250% of GDP by 2047.  The important point here is that governments by their nature tend to be less price-conscious than private individuals or entities, and therefore government spending is more inflationary. 


China, however, is the outlier here.  With CPI now negative and a property bubble being deflated, there is a risk that it falls into the same trap as Japan did in the 1990s.  The PBOC has run by far the loosest monetary policy in 2023, so it is concerning that domestic consumption is only picking up slowly from the 2022 low. 


Monetary policy is pivoting to a looser stance  


Last year we forecast that monetary policy would start to loosen in the second half of 2023.  That may not be apparent in the headline interest rates, though the Federal Reserve has indicated 75bps of reductions in 2024, but behind the scenes most central banks have been more accommodative.  China has been in the lead because of the problems in the real estate sector; Japan is also effectively printing money in order to maintain ten-year bond yields at its new target of 1%, still substantially lower than the rest of the world; only in Europe and the U.K. is monetary policy still tight. 


The jury is still out whether this pivot is needed to avoid a hard recession (the consensus view) or whether it will add fuel to inflationary tendencies.  We rather tend to the latter view, though more likely in the longer term and not immediately.  


The real danger is now monetary debasement in the longer term 


Last year we suggested that inflation would come down to a 3% to 5% range, with the risks on the upside.  Today we suggest that inflation will remain subdued in the short-term, probably in a 2 to 4% range.  The upward pressures will likely come from government demand and supply side costs i.e., focused on service industries; the downward ones from China i.e. focused on goods. 


We are much more concerned about the longer-term outlook.  The magic money-tree beckons for governments with debt service costs rising sharply and little political capital to use on reining in fiscal deficits.  Since the 1960s governments have been lucky in that they have either had stronger growth (1960s), lower debt levels (1970s through the 2000s) or low interest rates (2008 onwards).    


Looking forward all these seem likely to worsen.  Governments will be unable to borrow long-term on palatable terms and will be forced in some form to print money to balance their books.  The U.S. is already doing this, with over 50% of current financing short-term.  For us, the implication can only be higher inflation in the longer term. 


* Sources:  Nov 23 U.K. budget statement and U.S. Treasury.

** Congressional Budget Office.


If you would like to discuss anything in this article with the author, please visit our website at www.linchpin-advisory.com or contact us on research@linchpin-advisory.com. 




Linchpin Advisory Limited is a company registered in England and Wales, Company Number 11165480; registered address 7 Beaufort House, Beaufort Court, Sir Thomas Longley Road, Rochester, Kent ME2 4FB; VAT registration number 322850029.  This document is intended for professional investors, and nothing within it is or should be construed as constituting advice as defined by the Financial Conduct Authority.  If you are in any doubt about this, please consult your legal advisor.  The information contained has been obtained from sources believed reliable, but we do not represent that it is accurate or complete, and it should not be relied upon as such. 

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