Across the world, inflation is plunging. The last US Consumer Price Index (CPI) broke records – and not the good kind. Headline CPI declined 0.8% with gasoline, apparel, motor vehicle insurance, and airline fares all contributing to the drop. But it’s not just the overall decline we should be concerned about, it’s the month on month change in Core CPI (all items less food and energy) that’s got our attention. This index dropped 0.4%, representing the largest monthly decline in the history of the series, which dates to 1957.
The inevitable impact of COVID19
The latest CPI numbers are, in many ways, what is expected from recent market dynamics. We cannot go to work, we aren’t able to travel, and we have all been bound to home. The uncertainty of COVID-19 caused us all to grind to a halt. As a result, demand and overall consumer spending is down. What’s more, supply has halted, with production frozen across much of the world.
But something else is bubbling; low inflation. Across the globe, inflation rates are dropping. Eurozone inflation fell to 0.3% while in Canada the inflation rate turned negative for the first time since 2009. Some see this as an opportunity. Perhaps that is why we have seen mortgage applications for purchase, back to the same levels seen over the last three years. It suggests US consumers feel more positive than we had been led to believe.
Is it possible to have too much of a good thing?
Even if you take oil on its own, there is no question CPI will continue to decline. We will reach negative CPI by the end of the year, with our models predicting we will hit -2% by December. But as we know, there is more than just oil driving this shift. There are severe disruptions across much of the world’s supply chains which don’t look like they will ease any time soon.
The result will be deflation at the end of this year; lower economic activity and falling prices much like what we saw in the 1950s and 60s. With this drop, we can also expect consumer spending to stay relatively low, and savers penalized with low interest rates.
The knock-on effects
Amongst other things, metrics like the CPI are used as a guide to help businesses set their prices; from bond markets to the supply chain. As such, much of the economy could experience a structural modification in the coming months. It’s not going to take long for policymakers to crunch the numbers; 36 million people are currently unemployed. At the same time, big businesses are still making massive profits much of which is coming from fiscal stimulus. Laissez-faire economics and the business practices that have underpinned equity outperformance will come to an end.
Getting back to growth
Deflation is a given this year. What will be interesting, is what comes next. Governments across the world are planning to stimulate their economies with expansionary monetary policies and are already adopting measures beyond plain vanilla quantitative easing to boost results. As the economy starts to recover from COVID-19, we should expect inflation. Hedge against it. Investments in key areas like real commodities and being discerning about which stocks and bonds are in your portfolio offer the best protection.