FINANCE
DON’T WORRY ABOUT INFLATION (YET!) By Michael Brown, Senior Market Analyst at Caxton FX
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s the coronavirus pandemic shows signs of having reached its peak, at least for this infection wave, attention is beginning to turn to what comes next for the global economy; which is undoubtedly now in its first recession in over a decade, and likely in the deepest contraction since the ‘30s. One question that many are likely pondering is whether the post-virus economy brings with it an inflationary wave. In the immediate-term, as the world continues to grapple with getting the epidemic under control, disinflation is blatantly on the horizon. In the longer-term, however, an inflation wave is likely to surface, possibly before the year is out.
COLLAPSE IN CRUDE Firstly, let’s look at the current environment. At a very basic level, a recession is naturally a disinflationary environment; the drop, or collapse in this case, in demand caused by an economic downturn instinctively depresses prices. Furthermore, the recent collapse in crude prices – including US oil falling into negative territory for the first time
ever – sparked by a combination of the Saudi-Russia price war, and evaporating global demand, will naturally have a downward impact on CPI. It is, at this point, key to understand that without demand, you cannot have inflation. Until the coronavirus lockdown measures are lifted, there will not be a substantial pickup in demand. However, looking further ahead, the eventual pick-up in demand, combined with the present expansionary monetary policy environment, should see an inflationary wave return in the medium-term; especially given policymakers’ tendencies to allow economies to run ‘hot’.
A BOUNCE IN DEMAND? While some demand has undoubtedly been lost forever, nobody will be going for three haircuts on the same day to make up for those missed for example, there will be a near certain bounce in demand; especially as those who have been cooped up inside for weeks on end flock to businesses in the services
sector at the first taste of freedom. Even those who have, sadly, found themselves unemployed as a result of the coronavirus crisis will likely contribute to this demand surge due to the stronger social safety nets implemented by governments worldwide. Furthermore, it will be difficult for OPEC+ oil producers – particularly Saudi Arabia and Russia – to sustain themselves with oil close to $20bbl. As such, further production cuts remain a distinct possibility which, along with an eventual pick-up in demand, should help prices to recover at least some of the losses. For markets, an eventual return of inflation may dampen the attraction of bonds in the longer-term, with expansive asset purchase programmes from almost all G10 central banks set to keep yields relatively depressed. Meanwhile, a solid hedge against inflation has always been gold; while equity market returns will likely outpace that of bonds in the longer-term. In the FX world, a pick-up in inflation may have a rather muted impact, given the pick-up is likely to be relatively symmetrical across developed markets.
With foreign currency being a fundamental part of business, Caxton are providing a free consultation service to all members, available Monday to Friday 8am-6pm. Simply email kevin.bottwood@caxtonfx.com to arrange a time to speak or alternatively ask any questions you may have.
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