Anthony Rayner
Premier Miton Macro Thematic Multi Asset Team
For information purposes only. The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
There is a very loud and dominant narrative that inflation is falling. Indeed, headline inflation, or inflation across an entire economy, with nothing stripped out, is falling sharply across several major economies.
However, core inflation tells a very different story. This metric is considered a much better measure of underlying inflation, as it strips out food and energy. That might sound like cherry picking but stripping these two volatile components out actually has a lot of merit.
The price of food in the short term is often very much driven by changes in supply, which in turn is often driven by changing weather patterns. Similarly, the price of oil in the short term is often driven by changes in supply through the OPEC+ cartel. This is not to say that demand is not relevant but demand for food and oil tends to be steadier.
As a result, the majority of short-term changes in the price of food and oil will more likely be driven by supply than demand and, therefore, any price disturbance will likely be less related to a trend change in an economy’s underlying inflation.
That’s not to say that food and oil prices are not important, in part their importance is why their demand is so steady. They are of course crucial inputs into an economy and society, not to mention very politically sensitive, with sustained price rises in both or either often leading to civil unrest. To ignore them would be wrong but to focus only on the headline measure of inflation is also wrong. The chart below shows core inflation staying high, at above 5% and showing little signs of falling in each of these major economies.
Core CPI % in major Western economies
Source: Bloomberg from 29.05.2018 to 30.03.2023. Past performance is not a reliable indicator of future returns.
Another measure of inflation, services inflation, has a similar profile to core inflation in that it remains elevated in a historical context and shows little sign of falling either. Services inflation, due to its nature, tends to be much more domestic driven and especially wages driven, and so is also a key focus for policy makers.
Leaning into what the data is telling us
We don’t predict central bank action, or their bias, but we believe that policy makers will be data dependent to protect credibility. If core and services inflation remain higher for longer, we can expect interest rates to remain higher for longer too, as central banks understandably focus on these metrics more than the headline number.
This is very relevant for companies and financial markets. We already have the lagged impact of one of the fastest and largest rises in rates in play, but if rates remain high, and so keep the cost of capital high, there will be a higher bar for investments. It will continue to hurt the more indebted and speculative entities, with the safer and stronger likely to benefit. This is not just relevant across equity but also corporate bonds, as well as government bonds and their respective currencies.
In contrast, the immediate focus for markets seems to be whether the Fed can be the provider of liquidity again, to the degree that it pushes markets higher, as it was for many years before inflation returned. Understandably, the market’s focus is not on higher for longer rates and whether that might push the world to a more stagflationary environment.
This is not our base case but it is a scenario which we consider. Similarly, we believe it almost inevitable that the longer rates stay higher, the more likely things continue to break, see the evolving banking crisis.
Nevertheless, as is their custom, markets are taking a single-issue approach, with the narrative around falling inflation drowning out a more objective scenario analysis.
