World inflation has peaked, but .....

Well, at last I have updated all my databases.  Almost all!

This chart shows the CPI inflation rate for the Big 8 economies (US, UK, Europe, China, Japan, India, Brazil, Russia) weighted by GDP, alongside the percentage of 43 world economies where the CPI inflation rate is above 6%.  The moral of the story is that inflation is falling in the Big 8, and also in the world as a whole.  

Inflation is falling because the impact of Russia's invasion of Ukraine is fading (in the sense that it's not making inflation worse, so year-on-year rates are falling); because commodity prices are declining; because growth is slowing; and because China's inflation rate has gone negative (one sign of just how weak China's economy really is).  It'll prolly take another year, perhaps longer, for Big 8 inflation to get back to 2%. 

I think it quite likely that the longer-term underlying inflation rate has risen, because the key reason it got so low is offshoring and just-in-time manufacturing.  Goods were efficiently assembled from parts in different countries.  The progress of offshoring has stopped and reversed.   The war has shown that relying on other countries for key parts of your own country's manufacturing could be problematic, even disastrous.  Even in the absence of war, the lockdowns in China showed just how dependent manufacturing in developed countries was on the free flow of parts.  Tesla, which produces all its own chips, was unaffected by supply-chain breakdowns.  There is a lesson there for other CEOs.

We will never get back to the two decades of low inflation we have come to regard as the norm.  Whereas central banks struggled to raise inflation over these two decades, it is likely that they will now struggle to keep inflation at 2%.  Central to this is the realisation by the West that relying on China could be as strategically perilous as our naïve belief that Russia could be trusted and that we could rely on her for all our gas and oil.   I remember when Stephen Roach in 1989 (or thereabouts), when he was at Morgan Stanley, pointed out that the fall of the Iron Curtain, and the opening of Eastern Europe and China to world trade would drive the long-term rate of inflation down, and it did.   What we are seeing now is the partial reversal of this trend.  We no longer trust that politics will not impede trade. Globalisation is no longer fashionable.

Moreover, global warming has pushed up food inflation.  Who would have thought that alternating droughts and floods would push up food prices?  Amazing.  Well, greenhouse gas emissions continue to rise.  It will only get worse.

In other words, the fall in world inflation may be slower than in the cycles of the last 30 years, even if we have a deep recession, and underlying inflation will remain stubbornly high.  This has important implications for bond yields and PE ratios.  The major bull markets in asset prices were driven by a secular downtrend in inflation.  If that trend is over, valuation rates for all asset classes will rise, and that will keep their prices from rising.