The US Bureau of Labor Statistics reported Thursday that consumer prices had increased by 5% in May since a year earlier, the fastest increase since 2008. The month-on-month rise of 0.6% was also much higher than expected. The yield on US Treasurys, which typically rises when holders expect higher inflation, fell by about 5 basis points in the final two days of the week.
In the Eurozone, the 12-month inflation hit 2% in May, the central bank’s target which it had expected to reach only at year’s end. German inflation, announced May 31, surged to 2.5% from 2% in May. The yield on 10-year bunds, Europe’s benchmark for “risk-free” yield, has fallen about 0.1% to -0.27% since the inflation figure was released. Over the same period, Italian 10-year paper was down in yield from 0.91% to 0.75%.
Global bond yields did not rise even with the release of data on Wednesday that China’s producer prices had risen by 9% year-on-year in May, the fastest rise since 2008. Recall that low-cost exports from China were considered to be an important factor in keeping global inflation under check over the past decade.
What signals are global fixed income markets providing investors?
First, trust persists in the US Federal Reserve and the European Central Bank which have said repeatedly that the burst of inflation is temporary resulting from a one-shot surge in demand as economies open up after covid. Fed Chair Jerome Powell has emphasized that the central bank will continue bond purchases at the pandemic level of $120 billion per month. The central bank is likely to confirm at its next meeting on June 15 -16 that it will stay on this path.
Investors may also be taking heart from inflation expectations in the latest University of Michigan survey. An inflation rate of 4% during the next year, and an average annual rate of 2.8% over the next five years, in the June survey were both lower than the corresponding figures in May.
The story was no different in Europe. After the May Eurozone inflation figures were published, the ECB indicated June 10 that weekly bond purchases under its €1.85 Pandemic Emergency Purchase Program (PEPP) would be speeded up. The policy rate will continue at zero and the deposit rate at -0.5%, with ECB President Christine Lagarde saying at her press conference Thursday that the pickup in inflation would be temporary because underlying factors for sustained economic growth “are certainly not there”.
The only manifested instance of concern about inflation came from the Central Bank of Russia which hiked the policy rate from 5% to 5.5% on Friday because consumer prices had risen by 6% year-on-year in May from 5.5% in April. Another 0.5% rate hike may be in store within the next three months. Russian monetary policy in recent years has diverged significantly from G7 countries in recent years. Listening to Governor Elvira Nabuillina would give the impression of attending a lecture at a University of Chicago Economics classroom!
Developed country central banks’ nonchalance notwithstanding, the pressure of inflation is real and likely to be a medium-term phenomenon. Several factors point to this conclusion. First, global food prices have surged to a decade high, according to calculations by the United Nations’ Food and Agriculture Organization, reported by Bloomberg News. All components of the food index rose sharply last month with vegetable oils, grains and sugar heading the list.
Second, latest BLS data show that inflation so far has come from commodities other than food and energy which rose 6.5% over the past year. By comparison, the increase in the price of services other than energy increased by only 2.9% over the past twelve months, kept low by the cost of shelter (rent). With goods prices have risen first, expect services to be next in line to jump, making the inflation longer lasting.
Finally, inflation cannot be permanent unless there is continued money creation to feed the price surge. In the US, the Fed balance sheet is just shy of $8 trillion, having almost doubled since early 2020. Rather than remain sanguine and suggest that the price increase is transitory, Powell and his colleagues should fear being forced to undertake drastic action to cut back when inflation gets out of control.
President, Sri-Kumar Global Strategies, Inc.
Santa Monica, California 90401
June 13, 2021
Sri-Kumar Global Strategies, Inc. advises multinational investors and sovereign wealth funds on global risk and opportunities. Dr. Sri-Kumar is regularly featured on business TV and Radio media, and is a frequent speaker in global financial centers on major topics that affect markets and investments.
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