Monitoring Inflation Regime Change: 10 Things We're Watching

The DNA team present an anatomy of a potential inflation paradigm shift, a checklist of confirmatory signals, and the portfolio moves investors could consider.

 

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Introduction

In June 2020, with year-on-year headline inflation running at 0.6%, we published our Inflation Regime Roadmap , which suggested that the global economy might be on the cusp of a structural change toward an environment of higher and more volatile inflation.

Today, inflation is 5.4%. But we’re not going to be peacocking: our suggestion was never about a short-term, base effect-driven spike in inflation, but was rather a call for a new higher and more volatile inflation regime that could last 10 years or more. Indeed, we find the transitory arguments credible in many regards. Instead we detail our framework for monitoring the inflation data from here.¹ In the spirit of intellectual freedom, we will simply present the data and briefly describe why we think they’re useful. We won’t go through the entrails of what direction we think they’re pointing, save for a brief ‘traffic light’ (RED being high inflation risk, GREEN being low).²

Conclusion

So of the 10, on our eyeballing, we’re at RED = 5, AMBER = 2, GREEN = 3.

If we were to attach a score of 0 to green, 5 to amber and 10 to red (where 10 is high inflation risk), simple average would give us an overall score of 6.5.

Overall inflation score as of 13 July = 6.5

While we wouldn’t call that panic stations, it does indicate to us that there is enough pressure to the upside to make it worthwhile worth doing the risk management work now to ensure investors can respond quickly in the event we get more uniformly red signals.

1. For simplicity, we focus on just the US. Although we do watch inflation across the globe, we think this is a fair shortcut given it is unlikely to us that, in today’s globally interconnected world, an inflationary regime change in the US would not be exported worldwide.
2. If you would like a chat about how we got there, please get in touch with your relationship manager.
3. For indicators 3-9 we show the metric with 1 standard deviation from mean bands, based on trailing 3-year lookback. Below the lower band, the chart turns blue, above the upper band, red, and is grey in the neutral inter-band zone.
4. Currently – and in a one datapoint riposte to the idea that food is a swing factor in headline inflation – that’s brown bread.
5. Or thereabouts. The size and symmetry of the trim varies from month to month, but these details are beyond the scope of this article.
6. In case of interest, the three items most often excluded are: fresh vegetables, eggs and computers (not fuel interestingly). The three items least often excluded are other purchased meals (a sub-category of food away from home), owner-occupied stationary homes and casino gambling.
7. The mean item in the CPI basket changes price once every 4 months (ranging from once every 3 weeks for fresh tomatoes, to once every 6.5 years for coin operated launderettes).