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Weekly investment update – Transitory gets a boost

Recent rises in Covid cases are being monitored closely, not least for the possibility that a pickup in caseloads may affect reopening plans and crimp consumer confidence, capping the economic recovery. Brighter news from the US came this week in signs that inflationary pressures are now easing, vindicating the view of many central bankers.

Covid-19 update

Globally, daily new Covid cases have continued to ease and are now around 550 000 per day, led by an easing in infection rates in Asia and Africa over the past week.

In the US, infection rates have receded marginally to around 150 000 new cases a day, with hospitalisations reaching a plateau.

In China, after two weeks of close to zero transmissions, locally transmitted cases have risen, albeit just in one region. The country’s zero-tolerance approach to Covid-19 presents a downside risk to economic growth if transmissions pick up more broadly.

This point was underlined recently by the Singapore government’s decision to pause reopening plans after an increase in the caseload among the country’s 80% vaccinated population.

The Delta variant has already had a negative impact on consumer confidence and hiring in the US. This may well extend to August retail sales, which is scheduled for release on 16 September.

Sentiment among US consumers is expected to remain subdued through September. While infection rates appear to have eased, a more sustained reduction is probably needed before confidence rebounds.

Pace of US inflation slowed slightly in August

Data published on 14 September showed US consumer prices rose at a more moderate pace in August, suggesting that inflationary pressures associated with the economic reopening from Covid lockdowns are easing slightly after inflation reached a 13-year high in July.

The US consumer price index (CPI) rose by 5.3% in August from a year ago — just below the 5.4% reported previously. This was in line with the 5.3% consensus forecast. Month-on-month, price gains slowed to 0.3%. That is a significantly slower pace than the 0.9% jump between May and June, and a fall from the most recent 0.5% rise from June to July.

Core CPI (excluding volatile items such as food and energy) also decelerated. The monthly pace fell to 0.1%, marking the smallest increase since February. Over the last year, core inflation was up by 4% after a 4.3% rise in July.

Looking more transitory

The slowing of US inflation in August reflects a partial unwind of the large increases in the prices of used cars, transportation and hotel accommodation in late spring.

This supports the view that the inflation surprises of a few months ago would, in the language of the US Federal Reserve, prove ‘transitory’. As such, it will be welcomed by Fed chair Jay Powell.

Back to low-flation?

Few, however, ever believed that prices would continue to rise at nearly 1% a month indefinitely. The debate has always really been about what rate inflation would return to once the large demand/supply imbalances in sectors such as consumer services abate.

The real question is:

whether the US will see sustained inflation near or above 3% a year, or will the low-flation forces that dominated during the years before the pandemic return?

A key part of the answer to this question is housing prices. Housing is a major part (40%) of US core CPI and is correlated with the business cycle. The high weight means relatively small shifts in this component of US inflation can move the needle on the overall inflation outlook.

The Fed is hoping that inflation ultimately settles at a level a little above 2% once Covid moves into the rear-view mirror. A slightly higher rate of housing-related inflation than that seen before the pandemic might be a necessary part of that. Whether that slightly higher rate turns out to be 3.75% a year or 4.25% will matter a lot.

Supply chain distortions

In the near term, there are clearly still supply chain effects at work in the data. Assembly of new cars has been severely affected by a shortage of semiconductors, which has forced up the price of both new and used cars. Various other durable goods prices (e.g., furniture, TVs and the like), have risen due to Covid-related plant shutdowns in Asia and transportation cost pressures.

These factors look set to support higher inflation for at least several more months. Higher vaccination rates will be a key part of resolving these production issues. 

News from the ECB

At its 9 September council meeting, the European Central Bank announced a moderate slowdown in the pace of asset buying under its pandemic emergency purchasing programme (PEPP), in line with market expectations. President Lagarde reiterated the view that inflationary forces in the eurozone were temporary in nature.

Details on the future of the PEPP are expected in December. The programme may end next March,  perhaps replaced by an expanded and more flexible asset purchase programme.

With prolonged monetary accommodation maintained by the ECB, eurozone front-end interest rates are well anchored.

Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

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