It might not happen overnight, but the inflation and wages outbreak in the US is highly likely to end in sharp falls in stock and property prices, and the deaths of zombie companies, writes Chris Joye.
The contradictory cocktail of extremely high inflation, zero interest rates, tight labour markets, robust wages growth, elevated inflation expectations, and record asset prices should have you worried. But the party may not be over just yet…
Current conditions are, however, different because of the absence of an inflation shock between 2016 and 2018. To better understand the downside risks, it’s worth considering the deep disconnects in both the data and monetary policy settings.P500 is currently at its second-highest level in the last 140 years, surpassed only by the 2000 tech boom when it hit 44 times. Note that peak was quickly followed by a 50 per cent drop in US shares over the next two years.
The Greenspan Put, which pumped money into markets after the dotcom bust, ultimately ended in tears during the GFC.The currently very low US 10-year government bond yield of 1.5 per cent, which is a key discount rate proxy, is less than half its average level since 2000, and a full 100 basis points below the Fed’s 2.5 per cent estimate of its so-called “neutral” cash rate.
The world’s largest economy is recording the briskest wage growth since the early 2000s. On a six month annualised basis, US wages have expanded at a 4.1 per cent pace. Combined with a very low jobless rate of just 4.2 per cent , expectations of a higher cost of living may be fuelling more assertive wage claims, which workers can make as the balance of power shifts from employers to employees.
There is, of course, a role for all these tools when we get genuine market failures driven by exogenous shocks. The pandemic was the best possible example of this type of external event. But once the shock passes, the world should normalise. For the first time in a long time, we may face an unavoidable inflation-induced reckoning. To re-anchor inflation and consumer expectations, central banks may have to lift interest rates well-above their neutral levels. Much higher discount rates may in turn compel a savage downward rerating of asset prices.Two simple examples illustrate the lurking risks. Aussie house prices have appreciated more than 30 per cent since mid 2019 simply because mortgage rates declined by 100-125 basis points.
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