The playbook this year was supposed to be simple. The disinflation process was to continue and that will lead to major central banks cutting interest rates by a couple of times. The US economy in particular was supposed to hold up well and allow the Fed some breathing room to work with as Powell & co. look to shore up economic conditions.
Instead, we're starting to see recent data point to a flagging US economy. Meanwhile, it is Europe and the UK that have shown some resilience this year. That has bought the ECB and BOE some added time at least in navigating through their respective policies.
As for the disinflation process, we've sort of hit the brakes on that in the last one to two months. The good news is that we have seen price pressures fall over the past year across the globe. But the "easy" part was just that, in getting inflation down back to around 3%. The "hard" part is the here and now, in trying to bring that further back to around 2%.
Amid base effects and what not, major central banks are arguing that inflation will start to come down again in the latter stages of this year. It may happen but let's not forget, policymakers never have a good track record in calling these things. Remember how adamant they were back in 2021 that all of this was supposed to be transitory? It's now three years to that day.
Anyway, all of that brings us to where we are now when viewing the global economy. And that is facing the likelihood of inflation staying on the higher side for the next 4-5 months at least while economic conditions slow down further. Or more specifically, while the US economy slows down further.
The latter might push the Fed to cut rates sooner and you'd think that will be good news for broader markets and risk sentiment.
However, it is very much a balancing act right now. It is only good news so long as it is accompanied by the right reasons. Otherwise, not so much. And if major central banks are reluctant to budge in the battle against inflation, that will make the scene worse. If they don't cut rates while the economy slows down even more, that is not a positive recipe for risk trades.
That screams out stagflation and it is something market players will have to stand up and take notice. That is if they haven't already.
And not for the first time, the playbook in markets is not turning out to be that simple. It also definitely won't be the last.
