It’s just a phase: Three-minute macro

The inflation roller coaster

In June, we released a broad inflation outlook, and while that work has given us a robust framework from which to look at inflation, sometimes there’s value in a simpler approach. For this reason, we’ve developed a three-phase inflation framework. This framework underscores two core messages that we feel are paramount.  

First, it’s incredibly important that either inflation or disinflation arguments are applied to the correct timeline. For example, supply chain disruptions are near-term factors, while infrastructure is a long-term inflationary pressure.

Second, inflation is likely to be a roller-coaster ride in the next 18 months and we believe it’ll come in three phases. First, we expect a period—likely lasting through September—of sticky high prices, during which we expect to see a 3% to 4% inflation rate. Next, we’ll likely see a cooldown period, during which inflation worries temper, backing off to approximately 2% running into 2022. Lastly, in the post-COVID-19 (hopefully) world of 2023 and beyond, we expect slightly higher inflation as new factors such as deglobalization, monetary and fiscal policy adjustments, and the lagged effects of higher shelter costs work through.

Getting the inflation (and rates) call right means navigating these ups and downs as opposed to simply picking an inflation or disinflation side. 

Three phase inflation framework

Source: Manulife Investment Management, as of July 7, 2021. The views and opinions expressed here are for informational purposes only and are subject to change as market and other conditions warrant. 

FOMC damage is done

While U.S. Federal Reserve (Fed) policymakers have spent much of the last few weeks walking back their communication on conventional (interest rate) policy normalization at their June meeting, certain markets remain shell shocked. The USD remains higher, yields (at least beyond the very front end) are lower, and curves are flatter. These moves suggest that market participants may be reassessing the Fed’s reaction function, despite last year’s introduction of flexible average inflation targeting (FAIT) that followed the prior optimal control framework championed by (then-Vice Chair) Janet Yellen in 2012.

Despite its successful introduction at the 2020 Jackson Hole symposium, the Fed has struggled to properly communicate the parameters under which it would implement FAIT. Indeed, the June 2021 Fed meeting appeared to even dismiss the optimal control framework as the Summary of Economic Projections “dots” revealed a preference for higher and sooner rather than lower for longer; sooner hikes appear to imply a lower end point.

The policy uncertainty introduced by the Fed’s communication is worrisome as it implies a shift back toward traditional economic orthodoxy following 10+ years of post-global financial crisis evolution. The shift back toward orthodoxy itself is also worrisome, given that the Fed’s latest interventions reached a greater number of asset classes, most notably corporate credit.

Eurodollar curve, pre- and post-June FOMC meeting

Source: Manulife Investment Management, Macrobond Financial AB, Bloomberg, as of July 7, 2021. Eurodollar futures (via CME Group): "Eurodollars are U.S. dollars deposited in commercial banks outside the United States. Eurodollar futures prices reflect market expectations for interest rates on three-month Eurodollar deposits for specific dates in the future. Eurodollars are U.S. dollars deposited in commercial banks outside the United States."

Asian risks rise as the West reopens

While Asia was well placed last year to take advantage of the disruption in global supply chains and the surge in pandemic-related goods demand (electronics, personal protective equipment, toys, and furniture, etc.), its economy now faces a moment of truth as the West begins to reopen. Over the next few months, rising competition from increased global supply and decreased demand from the normalization in global consumption patterns will mean moderation in a key pillar of growth.

Looking at the May trade figures of China, India, Indonesia, Singapore, South Korea, and Taiwan, sequential export growth momentum has slowed drastically, from 18.60% month over month in March and 3.50% month over month in April to 0.55% in May. ¹ This is consistent with the decline in manufacturing PMIs in May from 53.3 to 52.3 (unweighted average basis).²

Since manufacturing exports have been a major pillar of growth for the region, and since performance of Asian financial assets is closely tied to the export outlook, we’ll be monitoring this in case of a more sustained downtrend. 

The performance of Asian financial markets is tied to the regional export outlook

% change year over year

Source: Manulife Investment Management, MSCI, Macrobond Financial AB, as of July 7, 2021. Asian currencies is a simple average of Indonesian Rupiah, Malaysian Ringgit, Philippine Peso, Singapore Dollar, South Korean Won, Taiwan New Dollar and Thai Baht, per U.S. Dollar. Emerging Asian Equities are represented by the MSCI EM Asia IMI Index, Total Return in USD. 

1 Macrobond, as of May 2021. 2 Macrobond, as of May 2021.