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As we shift from one quarterly outlook to the next, so does the narrative that dominates financial markets. Previously, markets shifted focus from the spread of the Omicron variant to the rise of inflation and the attendant central bank response. Now, this has raised increasing fears of a recession or a prolonged period of stagflation. Since the beginning of the year, inflation readings generally exceeded expectations, defying expectations of an imminent peak. In turn, this also dimmed hopes that authorities might be able to navigate the narrow path that contains inflation, yet limits the negative impact on growth.
Why has inflation been both so persistent and so hard to control? The inflation dynamics witnessed in various advanced economies reflect a series of simultaneously occurring factors: 1) a rise in both food and energy prices, 2) pressure from strengthening demand, especially in the US where fiscal transfers bolstered household savings during the pandemic, 3) disruptions to supply chains as a result of the emergence of new COVID-19 variants and inadequate policy responses, just when rising demand shifted from services towards goods. In addition, an overheating housing market led to a sharp rise in shelter prices in the US. Finally, the structural trend of economic dissociation of China and the West reverses parts of the gains made previously due to a globally integrated production chain.
Our view last year was that the rise in inflation was a temporary phenomenon that would begin to abate in early 2022 with the help of only limited central bank tightening. This has not happened as the invasion of Ukraine added another unforeseen shock to the system and recurrent lockdowns under China’s Zero-COVID policy added yet another complication. But we continue to think that inflation will be lower by year-end as energy price effects fizzle out, even if it remains more elevated (a multiple of target level) due to second round effects becoming entrenched. Only if demand were to weaken significantly, will inflation return near target levels.
Note: Up/down arrows indicate a positive or negative change in our asset allocation compared to the previous quarter. A dash indicates no change.
*The publication reflects asset performance up to May 21, 2022, and macro events and data releases up to June 17, 2022, unless indicated otherwise.
The information contained herein is obtained from sources believed by City of London Investment Management Company Limited to be accurate and reliable. No responsibility can be accepted under any circumstances for errors of fact or omission. Any forward looking statements or forecasts are based on assumptions and actual results may vary from any such statements or forecasts.
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