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On Thursday, 9 December, Deloitte’s global CEO, Punit Renjen, will be in discussion with former US Treasury Secretary, Professor Lawrence Summers, on the outlook for global growth and inflation. The webinar will take place at 16:00 GMT (UK)/11:00 Eastern Time (US). To attend or have a client attend, please register here.
Also, although the five-year breakeven is now at 2.8%, the so-called “five-year five-year” breakeven, which measures expected average inflation during the period between five and 10 years from now, has been steady and remains at about 2.2%. In other words, investors are confident that future inflation will be quite low. Thus, from an investor perspective, inflation is still seen as transitory—even though Fed Chairman Powell said that the word transitory ought to be retired because it has been misinterpreted. Meanwhile, the yield on the 10-year bond is down sharply, in line with declining expectations of inflation, hitting the lowest level since mid-September. This indicates that many investors expect lower inflation in the long-run and are not concerned that Fed purchases of bonds will soon cease. After all, US Treasury borrowing is expected to decline as fiscal stimulus ends. Thus, there will actually be a decline in the supply of bonds available to investors.
An important factor that could suppress inflation in the coming weeks and months is the fact that oil prices have fallen sharply in recent days, hitting the lowest level since August. This was driven by an expectation that the omicron variant of the virus will significantly suppress travel. Petrol (gasoline) prices are likely to follow. This will help to dampen inflation and will be politically favorable for President Biden. Only a drastic effort by OPEC could quickly reverse this trend. Fears about omicron also caused a sharp drop in coal prices.
Powell has been a strong proponent of the view that the current high inflation will be transitory. That is, he has argued that the inflation is largely due to supply chain disruption, which will abate over time. Therefore, he has suggested that inflation could revert to a normal level by 2023. That said, in last week’s testimony, he acknowledged that inflation, which initially was concentrated in a relatively small number of merchandise and service categories, is becoming more broad-based. Consequently, there is an increased risk of “persistently higher inflation.” As for the transitory argument, Powell said, “The word transitory has different meanings to different people. To many it carries a sense of short-lived. We tend to use it to mean that it won’t leave a permanent mark in the form of higher inflation. I think it’s probably a good time to retire that word and try to explain more clearly what we mean.”
Powell committed to fighting inflation, which has become the biggest concern of consumers as well as politicians. He said, “We understand that high inflation imposes significant burdens, especially on those less able to meet the higher costs of essentials like food, housing, and transportation. We will use our tools both to support the economy and a strong labor market and to prevent higher inflation from becoming entrenched.” Meanwhile, Powell acknowledged the risk from the new omicron variant of the virus and suggested that another outbreak could exacerbate inflation by further disrupting supply chains. He said, “The recent rise in COVID-19 cases and the emergence of the Omicron variant pose downside risks to employment and economic activity and increased uncertainty for inflation. Greater concerns about the virus could reduce people's willingness to work in person, which would slow progress in the labor market and intensify supply-chain disruptions.” In response to Powell’s comments, equity prices fell and bond yields increased.
When the US government released the employment report for November last week, some headline writers focused on the bad news. Yet the news from the report was mixed and, to some extent, confusing. On the one hand, the survey of establishments indicated slow growth in employment (which was the focus for headline writers). On the other hand, the survey of households indicated very rapid growth of employment, increasing labor force participation, and a sharp decline in the unemployment rate. Thus, one could either argue that the job market is decelerating or that it is accelerating. It is hard to say. Let’s look at the data.
There are two employment reports issued by the US government: One based on a survey of establishments; the other based on a survey of households. The establishment survey was disappointing in November, indicating the creation of only 210,000 new jobs—much less than forecasters expected, much less than predicted by a survey conducted by ADP, and much less than the 546,000 jobs created in October. What went wrong? The vast majority of the sharp deceleration of employment growth can be explained by just three industries: automotive manufacturing, retailing, and leisure and hospitality.
First, while overall manufacturing job growth was strong, there was a decline in employment at automotive producers, likely due to continued supply chain disruption stemming from a semiconductor shortage. Second, retail employment fell, largely due to a sharp decline in jobs at general merchandise stores and at apparel stores. These numbers are seasonally adjusted. Thus, it could be the case expansion of retail employment was slower than usual for the holiday season. Perhaps that reflects more online shopping or earlier holiday shopping. Third, employment in leisure and hospitality, having grown rapidly in October, barely grew in November. Job growth at both restaurants and hotels was feeble. It is not yet clear if this was due to reduced consumer demand or a persistent shortage of labor—or both. In any event, it should be noted that monthly movements in employment can be volatile, and that one month’s deceleration is not necessarily indicative of a trend.
Meanwhile, the separate survey of households tells a very different story. It says that the number of people choosing to participate in the labor force increased far faster than the working age population, thereby boosting the rate of participation. In addition, employment grew even faster, thereby causing the unemployment rate to fall from 4.6% in October to 4.2% in November. The survey estimates the creation of 1.1 million new jobs in November. The household survey includes self-employment, which may partly explain the relatively high number.
In response to the employment report, investors pushed down bond yields to the lowest level since mid-September. It is likely that they viewed the weak employment growth numbers as suggesting the possibility of slower growth. This, combined with continued uncertainty about the omicron variant, is likely causing a shift in market sentiment.
Meanwhile, the president of the Federal Reserve Bank of Cleveland, Loretta Mester, said that a significant outbreak of the omicron variant could fuel much higher and persistent inflation. She said, “If it turns out to be a bad variant it could exacerbate the upward price pressures we’ve seen from the supply-chain problems.” She also suggested that a new outbreak might prolong suppressed participation in the labor market. Thus, although omicron could derail the economic recovery by boosting social distancing, it could also cause an acceleration in inflation by disrupting supply chains and labor markets. It is not clear that investors have absorbed this argument into their expectations of inflation.
Inflation in the 19-member Eurozone continues to accelerate. The European Union reports that, in November, consumer prices were up 4.9% from a year earlier, the highest reading since July 1991. Prices were up 0.5% from the previous month. The November annual figure is also far above the 2.2% rate seen as recently as July 2021. In large part, the surge in inflation is due to the stunning 27.4% increase in energy prices. When volatile food and energy prices are excluded, core prices were up a more modest 2.6% in November versus a year earlier, and up only 0.1% from the previous month.
Inflation varied by country. From a year earlier, consumer prices were up 6.0% in Germany, 3.4% in France, 4.0% in Italy, 5.6% in Spain, 5.6% in the Netherlands, 7.1% in Belgium, 5.4% in Ireland, 2.7% in Portugal, and 4.3% in Greece. In addition, prices were up especially sharply in the Baltics with inflation of 8.4% in Estonia, 7.4% in Latvia, and 9.3% in Lithuania.
The new inflation data will surely put pressure on the European Central Bank (ECB) to remove monetary stimulus sooner than planned. Incoming German Finance Minister Christian Lindner said that “inflation gives rise to legitimate concerns.” However, the ECB leadership continues to say that the high inflation is likely due to one-off factors, including supply chain disruption, the rise in the German VAT, and the spike in energy prices. Still, ECB Vice President Guindos said that “bottlenecks may last longer than expected” in 2022. The pattern of inflation in the Eurozone is similar to that in the United States, although at a somewhat lower level. In both locations, goods inflation exceeds service inflation, reflecting a shift in demand that businesses are struggling to accommodate. This suggests that supply chain problems are the principal cause of higher inflation.
ECB President Christine Lagarde said, “I see an inflation profile that looks like a hump. And a hump eventually declines.” Consequently, she said that it is very unlikely that the ECB will raise interest rates anytime soon.
Also, with respect to the omicron variant, Lagarde said that there is uncertainty that will only be resolved once the scientists have more information. Until that happens, she said, “We need to very clearly indicate that we stand ready [to act] in both directions.” That is, if omicron causes the economy to slow substantially, the ECB might need to extend monetary stimulus. Or, if omicron serious disrupts supply chains, the ECB might have to tighten monetary policy. Unlike in the United States, current Eurozone inflation is mostly about energy prices. Core inflation in the Eurozone remains quite low. Lagarde says that, by the end of 2022, she expects energy prices to decline “significantly.”
Last year, Japan’s working age population was 13.9% smaller than at the peak in 1995. It is no wonder that the economy has grown slowly. In fact, the working age population is now smaller than in 1975. Thanks, in part, to government efforts to encourage female labor force participation, the labor force has been increasing in the last decade as more women are working. In addition, more people are retiring later and remaining in the labor force at an older age. These trends, along with an increase in immigration, have helped to offset the impact of a declining working age population.
The other way to offset the impact is to boost productivity. In the past decade, productivity did grow at a healthy pace. This reflected more investment in labor-saving and labor-augmenting technologies, offshoring of lower productivity tasks, and more efficient usage of existing workers. Still, despite the increase, the level of productivity (output per hour worked) remains lower in Japan than in most developed economies. In other words, there is considerable room for improvement. Industries that are exposed to global competition, such as automobiles and electronics, tend to be very productive. But many domestic industries are not, often restrained by anti-competitive regulations. Former Prime Minister Abe sought to lighten regulations as part of his “Abenomics” program, but progress was slow. Abe had likely hoped that Japan’s entry into the Trans-Pacific Partnership—by exposing more of Japan’s economy to global competition—would spur political support for deregulation and improvements in efficiency. But this hope faded when, in 2017, the United States withdrew from the agreement.