It’s been ages since I checked in on markets, but I am a happy, and a little dismayed, to report that investors and analysts are trampling around in the same weeds. Is inflation transitory or not? Will supply-side disruptions persist? And what about fiscal and monetary policy; will one loosen and the other tighten? In fairness, we have seen a shift in the economic outlook, for the worse. The reopening bump in economic activity, as virus restrictions were eased, is over, leaving economists to ponder what pace of growth to expect as the pandemic-induced macro volatility recedes. This moment was always coming, but almost on cue, we now have to contend with a litany of downside risks in the form of a real-income sapping rise in energy prices and a real estate crunch in China. These headwinds haven’t put much of a dent in risk assets, yet. The MSCI World and S&P 500 are down a paltry 1.5% and 2.5% from their highs at the start of September, respectively, and are still holding on to handsome year–to-date gains, 14.7% and 18.9%, respectively.
Read MoreThe more I think about the current debate about inflation, the more I am inclined towards the following remarkable conclusion. We currently do not have a good framework to explain inflation, neither cyclically nor structurally. Perhaps more appropriately, the old consensus among economists and policymakers on what inflation is, how it arises, and what to do about it has been severely challenged, if not shattered entirely. In a post-pandemic world of a clear, and almost textbook, inflationary mismatch between demand and supply, this has created the odd situation in which everyone is talking about inflation, and more recently inflation expectations, concluding that it either doesn’t matter or that we don’t understand how inflation works in the first place. Nowhere is this clearer than in the debate about whether presently high inflation is transitory or not. The thrust of this discussion has as much to do with the main interlocutors convincing each other that high inflation doesn’t matter, as it is about agreeing on what, in fact, transitory means.
Read MoreHaving just spent ten days on the beach in Ibiza, I am able to provide strong circumstantial evidence that European tourism is back, at least for a while. Granted, the clubs—which I am now too old to go to anyway—are still closed, but hotels, restaurants and beaches were full as ever. Given that 80-to-90% of activity on the island takes place outside, in a sunny and relatively windy coastal environment, the virus wasn't much of a threat, even though numbers had been climbing prior to our arrival. Indoor mask mandates, which are now commonplace, really was the only sign of the virus as far as we were concerned, notwithstanding having to navigate the byzantine testing and tracking rules for travel. The Dutch nurse who performed our pre-travel Covid-test informed me and my wife that tour operators on the island had hoped that August this year would see activity levels return to 50% of its 2019 level, before claiming that the true number is closer to 80%, and that operators are expecting to extend the season into October. If that's true, it adds to the evidence that economic activity in Europe will improve further in the next few months. That’s good news.
Read MoreThe finance and economics commentariat has been busy in the past few months educating each other about what inflation is, and what isn’t. To re-cap, just because prices are going up doesn’t mean that inflation is. Inflation, after all, is the rate at which prices are advancing, not the fact that prices are rising in themselves. More specifically, just because prices go up a lot in period 1, inflation can’t really be said to be accelerating unless the rate at which prices go up is higher in period 2, 3 and so on. To complete the circle; if prices were falling, we’d call it deflation, and the same argument on the rate of decline would apply, with an inverse sign. The amount of time spent by economists pointing out this trivial point is mostly an attempt to assure each other, and policymakers, that the spectacular CPI and PPI headlines we presently see on the screens are nothing to worry about. It follows that slowing the pace of asset purchases, not to mention raising interest rates, would be a grave and unforgivable error.
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