This week Christian Ulbrich, chief executive of the JLL global real estate group, has been prowling around the World Economic Forum in Davos, trying, like other executives, to parse a confusing world. One of his conclusions, he says, is that CEOs are surprisingly optimistic about future growth. Another is that the inflationary regime has changed.
The Davos elite used to view a 2 per cent inflation rate as normal, not least because it was embedded in central bank targets. But now “we have a lot of fundamental trends” which mean that “inflation will stay persistently around 5 per cent”, Ulbrich says. He expects that “interest rates will stay around 5 per cent too”, noting that this will push down real estate prices. For Ulbrich and his ilk, in other words, four (or five) is the new two.
Investors should take note. This week, global bond markets have signalled an end to last year’s inflationary scare. Ten-year treasury yields, for example, have tumbled to around 3.3 per cent after news of lower consumer and producer price growth, and prices imply further inflation declines next year, as the rate cycle turns.
To some financiers, this makes sense. Anne Walsh, chief investment officer of Guggenheim, for example, expects US inflation to be under 3 per cent by the end of 2023 since “many of the factors that drove inflation higher [like supply bottlenecks] are now reversing sharply”.
Maybe so. But this seems to be a minority view. For while most Davos attendees do not expect to see the world return to last year’s inflation shock, and double-digit rates, they do not anticipate a return to the pre-2019 pattern of ultra-low inflation and near zero interest rates either. The base has changed.
Why? One factor is China. At the start of this month, the World Economic Forum organisers seemed doubtful whether Beijing would even send a delegation to Davos this year. But one surprise of the week has been that Liu He, Chinese vice-premier, publicly addressed the event, and insisted that China is reopening and re-engaging with the world.
In private dinners, he has underscored this message even more forcefully. That has boosted executive optimism about global growth. But the rub, as Nicolai Tangen, head of Norway’s oil fund, observes is that China’s return creates a “big, big uncertainty [over] what will happen with global inflation”. A decade ago China was a deflationary force; now it is more likely to boost commodity demand — and global prices.
A second issue is supply chains. This year’s meeting has revealed that most executives expect far less US-China decoupling than Washington rhetoric might currently imply. “It is just not realistic,” says one tech CEO.
But the debates have also shown that almost every corporate board is restructuring their supply chains to create more flexibility and resilience, in anticipation of future shocks. That will inevitably raise costs in the medium to long term, since “wherever we are moving our production has higher wages”, as one manufacturing CEO says, stressing this is a multiyear process.
A third issue is the environment. Last year’s rightwing backlash against the environmental social and governance movement has left some executives — particularly those based in America and/or running big banks — increasingly wary of extolling their ESG credentials. “Green hushing” is afoot.
However, few corporate boards seem to be backing away from their decarbonisation plans. On the contrary, they are accelerating — particularly in America, following the contentious Inflation Reduction Act.
Green warriors tend to think (or pray) that decarbonisation will be deflationary in the long term, since the cost of renewable energy is falling. Hopefully so. But in the short to medium term, most CEOs see this shift as another big cost pressure, since the components and skills needed for a green transition are in short supply. They are almost certainly correct.
Then there is a fourth, more subtle, factor: the cultural zeitgeist. Until recently, most Davos attendees thought they lived in a free-market world in which global competition would inexorably cap the cost of labour and goods. But the war in Ukraine, US-China tensions, the Covid-19 pandemic and social unrest are creating a new global political economy: more government intervention, restive labour and a constant threat of protectionism.
Chief executives do not know how long this might last. But, quite rightly, they sense that almost every aspect of this new regime could be inflationary — not just in the short term, but in the medium term as well.
Of course there is at least one wild card in this outlook: if central banks such as the US Federal Reserve remain truly committed to their 2 per cent targets, they might yet crush economic activity in a way that delivers this.
But the longer the Davos cabal thinks that “four is the new two”, the harder the Fed’s task is likely to be — in both a political and economic sense. Or, to put it another way, those bond investors who are now betting that we will return to the benign inflation patterns of the past may be ignoring the nature of the new political economy. It is structural shifts, not just business cycles, that matter now.
gillian.tett@ft.com
Source: Economy - ft.com
