The US Consumer Price Index rose by 7.9 percent through February, the fastest pace of annual inflation in 40 years. 

Long before the pandemic, we suggested that there were two particular factors that suggested rising inflation; deglobalisation and deteriorating demographics. We could have thrown other factors into the mix, such as rapid monetary expansion but these two were the key drivers in our view. Admittedly, neither had appeared to lift inflation much before the pandemic, but our sense was that higher prices would come in time.

In essence, the seeds of higher inflation had been planted. They had been planted by increased evidence of deglobalisation, not least the US/China trade war under former US president Trump. As a result, the number of global trade disputes was rising as were average tariffs. The US, in particular, was also putting pressure on companies to reshore their activities. This pressure for higher prices was compounded by deteriorating demographics as the dependency ratio in developed countries (the proportion of retirees to working age population) started its sharp rise. More retirees relative to working people adds demand relative to supply and so increases pressure on prices, particularly if deglobalisation is reducing the ability of advanced countries to source more supply from developing nations such as China. In short, price pressures seemed likely to rise before Covid. The effect of the pandemic has been to jet-propel these inflationary dynamics.

On deglobalisation, there’s been a number of adverse effects. For a start, there’s trust issues with China resulting from question marks over the origins of the pandemic. In addition, the fragility of supply chains has been exposed (and perhaps further exposed when it comes to energy supply by the Russia/Ukraine conflict). As a result, issues such as reshoring and ensuring the security of supply seem to have become paramount, sending deglobalisation into overdrive and, with it, pressure for much higher prices.

Demographics too have been adversely impacted as reflected in what’s been called the “great resignation”, particularly in the US, as workers quit the workforce. This clearly increases the number of retirees relative to the working age population and so adds another layer of price pressure.

In our view, the key decision investors and policymakers have to make is whether these increased inflation pressures represent “good” or “bad” trends. We say “good” trends because we should not forget that actual inflation was generally too low before the pandemic. If the pandemic – plus the added supply shock of the Russia/Ukraine conflict – pushes inflation to central bank target levels (which are generally around 2%) over time, then these deglobalisation and demographic influences will have been “good” ones.

For a start, they will help stop central banks from hitting the zero policy rate limit  that has been a constant problem for many since the financial crisis. But equally, the supercharged deglobalisation and adverse demographics from the pandemic could create an inflation environment that is far above 2% targets even once some of the froth of the current inflation wears off, and that would clearly be a very bad outcome for financial markets and asset prices. It will clearly take some time before we know which one it is. Policymakers and markets are betting that the eventual outcome will be a ‘good’ one. We have our doubts because Covid-related price strains just add to the underlying price pressure that was already developing before the pandemic started or the Russia/Ukraine conflict began.