The Fed’s blindspot on global inflation drivers

What is the reason for the rise in inflation and why are the central banks playing their hands wrong?

China: “One-Country Test on Global Inflation”

“Monetary policy in the possession of a Pincer movement”, Claudio Borrio et al. Discuss the effects of globalization, particularly China’s entry into the World Trade Organization (WTO) and the collapse of the Soviet Union, and the structural disinfection pressures that have exacerbated the catalyst for domestic inflation in developed economies:

“A potential candidate is globalization, especially the entry of former communist countries into the trade system and many emerging market economies that have liberalized their markets – countries that also had a tendency to resist exchange rate increases. Elsewhere (Borrio (2017)) more detailed and documented The entry and greater dominance of such producers has probably weakened the price capacity of farms and, above all, labor, making the market more competitive. , While maintaining equilibrium, real economic developments could create a continuously downward pressure on inflation, possibly surpassing the cyclical effect of overall demand.

Monetary policy is effective in addressing cyclical deficits – such as market volatility after a financial crisis – but ineffective against structural change. However, major monetary authorities are still no different from the cyclical weakness caused by structural sterilization pressure from China and the long-term structural change in the global price chain (GVC) of the former Soviet states.

This has contributed to the central bank’s asymmetric policy response which is aggressively easy but terribly drastic, as long as inflation remains below target, ignorant of structural vs. cyclical factors. Such as Borio et al. Enter:

“The second reason is the unequal policy response to the ongoing financial and business cycle in the context of the existing germ-free tailwind associated with globalization. In particular, there was evidence of the economic recovery of the 1980s and 1990s and the unequal response around the chest and around the GFC. As long as inflation remained low and stable, there was no incentive for the central bank to tighten policy during the financial recovery that preceded the financial pressure in both cases. But there was a strong motivation to fight the chest and respond aggressively and decisively to prevent any deflation threat.

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Against the background of this policy, a structural disinfection factor has been interpreted as a cyclical deficit to demand an aggressive financial response, as well as to tighten cowardly and delayed policy adherence. Stable low interest rates strengthen low-productivity sectors such as real estate and accelerate the misuse of resources.

Indeed, the confrontation between the central bank’s structural and cyclical inflation drivers enables China to make a significant quantitative easing (QE), although the “one-country test on global inflation” has since attracted more market attention.

Chinese producers pass downward high prices amid rising cost id.

After working for almost two decades as a “global inflation reducer”, Chinese producers faced a perfect storm of margin contraction in the first half of 2021 between simultaneous supply disruptions and demand recovery. Qu observed, the instability of global products from crude and iron ore to copper – together responsible for the 70% movement of China’s producer price index (PPI) – pushed input costs to record levels.

Such an increase in spending creates a policy response designed to prevent subsequent inflation. Macro investors acknowledge the continued rise in the price of U.S. imports on products made in China, although many disagree on the effectiveness of price control measures or whether the recovery of the dollar, driven by the U.S. Federal Reserve’s hawkish response, will cool stable markets.

The rise in U.S. import prices is intuitive: Chinese producers cannot act as the gatekeepers of world inflation indefinitely amid high price input costs. Although some observers, among them Qu, feel that the price-absorbing effect remains intact, higher available import price supports the thesis that rising input costs have mitigated the impact of inflation.

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Central bank inflation risks dissent from “blind spot”

If the Fed and other major central banks stick to the existing structure and do not make structural differences from the cyclical inflation catalyst, China’s less effective “inflation suppressor” capabilities could change the fundamental market.

Under a strong dollar and a successful price control campaign by Chinese regulators and the renewable global product vulnerability due to the Hawkish Fed, Chinese producers may resume sterilization exports and contribute to consolidating Fed projects as a “transient” inflation outlook. This, however, does not break new ground in asset valuation.

Conversely, the failed price control of Chinese authorities and continued commodity power could increase pressure on Chinese producers and lead to further inflation in developed economies. Very few investors have experience of risk management in higher inflation, and exits from the Dow Fed policy, or policy patronage in asset prices, risky assets and government bonds can be equally risky (for risk-equity complexes and leveraged strategies).

The Fed could change course and consider inflationary pressures from China as “structural” in nature and determine that it does not guarantee a change in policy. But it will likely increase public scrutiny and political risk, especially since former Fed officials play important government roles and lead influential research institutions. Thus, some may interpret the reconsideration of past policy as a “policy error.”

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Market participants face unequal risk rewards: relying on China to have an “inflation blackhole” to justify low-inflation stagnation and long-term policy accommodation, or anticipate a change in inflation regime that boosts key asset markets. The probability of this result is almost the same, but the stabilization scenario could result in an increase in the value of the term asset, while further sustained inflationary pressures could re-determine a significant downturn across “policy-backed assets”.

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All posts are the author’s opinion. As such, they should not be construed as investment advice, or the opinions expressed must not reflect the views of the CFA Institute or the author’s employer.

Photo Credit: ©GettyImage / DavidPhilion

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Victor Jing

Victor Jing is the founder and portfolio manager of Kexelias Inc. and a former fixed income trading analyst at Capital Group Company focusing on monetary policy, inflation-related bonds and interest rate markets.

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