Authors: Robin Wigglesworth
Source: The Financial Times ( )

Rising inflation and the likely liquidity tightening would be the foremost risk to financial markets most market participants would agree in the current environment. Whilst we did feature a piece last week on how the broken global supply chain is causing persistent inflation, as Milton Friedman quoted “inflation is always and everywhere a monetary phenomenon that arises from a more rapid expansion in the quantity of money than in total output.” So as the central banks of Canada and Australia have already begun the tightening journey, will the more meaningful central banks – Fed, ECB and the BoJ follow suit and end the liquidity fuelled party in financial assets. In this piece, Robin Wigglesworth argues why that is unlikely to be the case.
“For sure, the direction of travel is clear. Inflation has indeed jumped higher and stayed elevated for longer than many central bankers predicted earlier this year. There is a risk that disorderly supply chains ripple through the global economy and cause inflation to run uncomfortably hot.
Most of all, the economic recovery from the coronavirus has been wonderfully strong. So it makes sense that central banks start scaling back emergency stimulus, and in some cases even start raising interest rates cautiously.
However, the current narrative feels a little too elegant. As if it has sprung fully formed from the fevered dreams of long-frustrated hedge fund managers or crypto utopians that have been wrongly predicting runaway inflation for years. Fears of serious, durable inflation, aggressive central bank action and subsequent financial market chaos are still wildly premature.
The violence of the recent short-term bond sell-off looks like it has been exacerbated by hedge funds being forced to liquidate trades. Notably, longer-term government bonds remain sedate. That reflects the view that inflation is accelerating but will still ultimately settle back down to the low levels seen over the past few decades.
After all, the forces that have battered down inflation since the 1980s — such as globalisation, technology, demographics, debt burdens and the weakening bargaining power of labour — are unlikely to reverse.
The bond market’s overall message is that the real danger is central banks losing their nerve and overreacting to something that they in practice have little control over. Raising rates will not fix congested ports, logistical bottlenecks, selective labour shortages or under-investment in energy infrastructure. But doing so prematurely could hamstring the economic recovery.
A few notable exceptions aside, such a mistake still seems unlikely. The three central banks that actually matter are the Fed, the European Central Bank and the Bank of Japan. None is likely to slam on the brakes soon, even if inflation does not immediately begin to subside. A new monetary regime is starting, but the reality is that it will probably look uncannily much like the last one.”

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