The Covid-19 crisis has changed the global inflation picture. Inflation risks are now larger than disinflation risks for the first time in decades. Here are five reasons why, according to Nordea Chief Global Strategist Andreas Steno Larsen.
For much of the time following the 2008 financial crisis, inflation has remained exceptionally low. Central banks have used aggressive and innovative policies, including negative interest rates, in an effort to lift inflation closer to targeted levels.
Now, the tide could be turning due to the Covid-19 crisis, according to Andreas Steno Larsen, Chief Global Strategist at Nordea Markets.
“The Covid-19 crisis has led to a political regime shift, and, for the first time in decades, we’re seeing a decent possibility of true inflation,” says Larsen, who recently kicked off this year’s Cash & Treasury Management conference with a presentation on the subject.
He boiled the inflationary regime shift down to five key factors – what he calls the “5 Ds.”
The ‘5 Ds’ and the return of inflation
With the surge in the Delta variant, supply chains remain distressed, particularly in Asia, where a “zero Covid” strategy has been widespread. Over the summer, new Covid-19 cases triggered partial lockdowns in several major ports in China, sending freight benchmark rates soaring.
One effect has been a surge in used car prices in the US, which is linked back to the supply chain disruptions in Asia and a shortage in the supply of chips used in new cars.
“You know something is wrong when the price of a used Mazda increases 50%,” Larsen told the audience, adding, “This is inflation, though maybe not the kind we would like to see.”
He also encouraged the audience to get a head start on buying their Christmas presents this year.
“Inventories are already low, restrictions high, and delivery times are still increasing,” he warned.
While Covid-19 may have triggered a supply crisis, Larsen does not see a demand crisis. Nevertheless, governments have treated it as a demand crisis, going to great lengths to support the consumer.
“Politicians decided to prop up demand in every way they could,” he said.
That’s where “dignity” has been reintroduced into fiscal policy, he added. Bailouts have been given to practically every sector and household, especially in the US but also in Europe. Larsen calls the new fiscal regime “Oprahnomics” (a reference to US talk show host Oprah Winfrey’s practice of giving everyone in her audience a new car).
The stimulus checks sent to every household in the US are “close to a de facto universal basic income,” he said, adding that “it’s tricky to get rid of such a programme once you’ve implemented it.”
This extreme demand stimulus during a supply crisis has turned the labour market upside down, giving workers the upper hand over employers for the first time in decades. Reports from businesses of difficulties filling job vacancies are record high.
“Ultimately this supply side crisis will end up in a classic inflationary scenario with wage growth,” said Larsen.
Ultimately this supply side crisis will end up in a classic inflationary scenario with wage growth.
Chief Global Strategist Andreas Steno Larsen
Persistent supply chain disruptions due to the virus could also increase the incentives to move parts of the supply chain back onto home soil.
Global mobility has also been thrown back decades, due to travel restrictions and the practical obstacles to moving around. That lack of mobility has repercussions for the labour market, reinforcing labour shortages and mounting wage pressures.
The Covid-19 supply crisis and the rising prices of basic necessities have fed into political turmoil. South African riots and the resurgence of the Taliban in Afghanistan coincided with the rapid increase in food prices over the past year, a similar pattern to that seen with the Arab spring in 2011.
“Expect more regime shifts across the globe,” Larsen told the audience.
5) The dollar
Finally, the strong inflation outlook paves the way for dollar rebound and a growing policy divergence between the US Federal Reserve and the European Central Bank. The tight US labour market will likely lead to accelerating wage growth – the exact kind of inflation the Fed is looking for. Nordea expects the first interest rate hike from the Fed in September 2022, followed by another three hikes in 2023, while the ECB remains on hold.
Read Larsen’s related Research article, which adds a couple more Ds: 7 reasons why Covid-19 could lead to an inflationary regime shift
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