#3rdIFIS 2021 – Global Inflation and Interest Rate Outlook

CFA Society India, in collaboration with CFA Institute, the Global Association of Investment Professionals, hosted its 3^rd India Fixed Income Summit 2021 during December 17 – 18, 2021.

The virtual conference provided an excellent opportunity for over 260 registered delegates to learn and network with some of the best minds in the industry and fellow CFA® charterholders. In the 3rd edition of CFA Society India’s Fixed Income Summit, we delved deeper into topics that have generated significant interest in the minds of investors, policymakers, researchers and analysts connected with India’s Fixed Income (FI) markets. One such topic of interest was ‘Global Inflation and Interest Rate Outlook’ that was covered by Vaibhav Tandon, Chief Economist, Global Risk Management, Northern Trust.

After a devastating 2020, where we witnessed record contractions worldwide, global activity and output in 2021 has surpassed its pre-pandemic level in several markets, despite the Delta variant of COVID-19 producing a late-summer setback. Pent-up demand and savings along with government support are fueling activities. Some economies have recovered faster than the others, with China leading and Japan lagging behind. Activity should improve everywhere in 2022, but not at the same pace across economies, says Vaibhav.

As regards inflation, it remains high – with demand being high, but supply response being slow. Inflation was at 1% early in 2021, but is well over Central Bank targets now causing worry, says Vaibhav. The recent surge in inflation isn’t entirely transitory, and represents a risk.

The pandemic policy has renewed the global housing boom with Quantitative Easing (QE) holding down borrowing costs, fiscal support to households, and consumer preference transitioning towards better home and living. And this element doesn’t appear to be transitory. Per IMF, a 10% increase in home prices, adds 2% to inflation.

Another factor is the food prices. The global food prices have been rising due to transportation difficulties, logistics limitations, poor harvests, energy costs, trade frictions, etc. However, he feels that we are yet to see a significant surge at the consumer level. Any large surge or swing in this aspect could hurt all around – advanced economies and the emerging markets.

Third important component that is pushing the headline inflation up is the energy prices. The pandemic created a glut of oil and gas supply and with constrained storage in some markets, prices declined. But renewed demand placed a premium on energy but low prices caused some defaults and restructuring among key producers hurting the output. Additionally, the transition towards green and clean energy is an impressive one to look out for – the speed of change and its impact on energy prices.

Overall, the pandemic has fouled global supply chains. The outbreak has caused disruptions at factories, ports, and distribution centers, with backlogs at key nodes remaining substantial. To cope up with this, re-shoring is under consideration. We have seen talks of moving supply chains away from China to different parts of the world to avoid facing similar crisis. But reorientation of the supply chain geography is not an easy thing to do as it is a time-consuming process and requires substantial consideration of financial resources and operational capabilities as well as government approvals. If materialized, China is most at risk of losing business.

Besides material shortage, labor force contributed equally to cause inflation. Lower participation accelerated wage gains, which are aiding higher prices, opines Vaibhav. Though competitive and large-scale companies are successful in passing along the increased costs to their customers. It is to be noted that employment has recovered significantly from the pandemic lows, but the recovery has been uneven across sectors and geography.

How are Central Banks responding to the pandemic and the inflation? They stepped forward aggressively to assist with pandemic relief with QE programs being initiated. The interest rates around the world are still low, however, the Bank of England made the first major move, recently, of raising the interest rates. The Federal Reserve is unlikely to raise rates until 2022.

Coming to the business cycle signals, amid all high inflation prints and concerns about the new variants, Omicron, the bond markets are constantly flashing warning signals about the growth prospects. The gap between the long-term and short-term interest rates have narrowed.

Talking about the key transitions into 2022, Vaibhav believes that balancing economic and public health will continue to challenge policy makers. We all are still learning to live with the new normal. Secondly, de-globalization that has been talked about since 2008 financial crisis, fouled supply chains and economic nationalism are causing countries to disengage. Also, there are populist movements that are less supportive of international commerce and immigration, but inflation issues will hold it back. Lastly, the drive to digitize, i.e., accelerated adoption of technology and work redesign will have profound impacts on economies and societies.  Also, cryptos are here to stay and while it is a headache for central bankers, they are coming up with their own version and it does not constrain their power says Vaibhav Tandon.

Though the near-term trajectory of inflation is highly uncertain and the risk is still to the upside, the house believes it will be interesting to see how the economy performs in 2022 and beyond with pandemic persisting, policy retreat happening, and interest rate increase rising in likelihood for 2022. Economic growth will have to progress without the same degree of policy support.