There is a raging debate about US inflation right now and whether it will be sticky. But more importantly, there's a debate about the inflation regime that we're in right now. We spent 20 years before covid in an era of disinflation and many believe we're in a new era of higher inflation.
US investors tend to be overly-focused on the US and US economic history, with a blind spot towards what's happening in the rest of the world. Often, the global signal is the one that cuts through the noise. Remember, it wasn't just the US in a disinflationary period before covid, it was the whole world.
So what's happening in the rest of the world with inflation right now:
- UK CPI 3.4% y/y vs 3.5% expected and 4.0% prior
- German HICP 2.3% y/y vs 2.4% expected and 2.7% prior
- Eurozone HICP 2.4% vs 2.6% expected and 2.6% prior
- Canada March CPI 2.8% y/y vs 3.1% expected. BOC core 2.1% y/y
- Mexico March core CPI 0.44% m/m vs +0.51%. Headline 4.42% vs 4.50% y/y expected
- China March CPI +0.4% y/y vs +0.7% prior, including -0.5% m/m
Contrast that with the US, which has had three high inflation reports in a row including in Wednesday's report, which rose 3.5% y/y compared to 3.4% expected.
Despite the US setback, increasingly believe there is an emerging picture of a return to the type of inflation that dominated the first 20 years of the century. The counter-argument is that globalization is in retreat but I don't see it that way. Globalization is slowing but the dividends are still being collected and given the current slowdown in China, it's exporting as much deflation as ever.
It's also obvious to me that AI, automation and robotics will be deflationary forces (though not in commodity markets initially).
Why is the US running against the trend?
A few things I'm thinking about:
1) Fiscal spending
The US hasn't pulled back on fiscal spending in the post-covid period. The Federal government is running deficits at 6-7% of GDP as the money from the IRA and CHIPS Act continues to work through the economy in 2024 and 2025.
2) US consumers own stocks
Americans are much likelier to hold equities in their savings portfolios than almost anyone. Needless to say, it's been an incredible bull market and given the wealth in America already, it's left consumers flush. Add in 30-year fixed mortgages, pandemic handouts and a tigher labor market and the US has been supercharged.
3) Housing data skews
The Fed's Goolsbee spoke at length this month about quirks in US housing data that could be skewing the picture. Market-based rents have fallen from the peaks but that hasn't worked its way into the CPI yet. It should but the numbers have stayed stubbornly high. It's something people will be watching very carefully and I worry that there is plenty of pent-up demand from US housing in the longer term.
4) Healthcare
What makes the US unique from most of the developed world? Private health care. Note the components that were upside drivers in the latest Dallas Fed Trimmed PCE report (month-over-month annualized changes):
- Net health insurance +15.5%
- Physician services +1.8%
- Financial service charges, fees, and commissions +3.5%
- Nonprofit hospitals' services to households +3.8%
- Government hospitals +3.8%
- Electricity +4.0%
- Motor vehicle maintenance and repair +4.8%
- Other purchased meals +4.1%
- Dental services +5.3%
Often these numbers reset at the turn of the year so there could be something of a one-off here that's not captured by seasonal adjustments but they could also be a stubborn source of inflation that differentiates the US from elsewhere.
Eventually though, it will normalize and we will find ourselves back in a low-inflation era. For now, inflation scares are proving to be opportunities to lean into that theme but with these factors, it will take some time for US inflation to converge to the rest of the world. US fiscal spending will stay high through 2025 but after that it will slow, perhaps dramatically depending on the results of the US election.
In the meantime, we may still be in the middle innings of the US dollar bull market. As the divergence persists and other central banks lower rates, the dollar has abundant room to out-perform.
