Although G5 inflation has returned to its pre-pandemic trajectory (-2%), the average masks the growing asynchrony. Apart from some fluctuations in China, inflation in the United States, the United Kingdom, the Eurozone, and Japan has remained astonishingly consistent over the past three decades: deflationary trends dominated from the 1990s to 2020, followed by a simultaneous surge in 2021-2022 due to the global pandemic, and then dropped rapidly in 2023-2024 as well. However, over the past six months, evidence of asynchrony has been accumulating continuously. Deflation has intensified in China and the Eurozone, while inflation has remained high in the UK and Japan.
Inflation and Policy Uncertainty
Although the goals of the Federal Reserve have been achieved, the chaotic policies of “Trump 2.0” (such as tariffs, trade, and immigration policies) are threatening the stability of inflation in the United States. Are investors facing a world where inflation outcomes are more volatile (and thus monetary policies are often out of sync), or a new equilibrium of persistently high inflation and even the possibility of falling into stagflation?
The Era of Low Interest Rates
Whether called “secular stagnation” (no growth without stimulus) or in more professional terms “decline in the real neutral interest rate,” both generations of investors have grown up in a deflationary world, an era driven by the integration of technology and financialization. This era is conducive to the appreciation of most assets, especially those closest to the source of debt (such as financial and speculative assets) and digital capital. The decline in real interest rates (from 3-4% in the United States in the 1980s to 0.5-1%, while in the Eurozone and Japan it was -50 to -100 basis points) has left central banks with no choice but to stimulate the economy by cutting interest rates and injecting liquidity.
Social and Political Backlash
However, the strong opposition of society to the consequent inequality and unfairness, as well as the erosion of human value (that is, the diminishing marginal utility of labor) and the depreciation of traditional capital, have created a harmful atmosphere. Whether it is the unorthodox election results such as the rapid swing from the right to the left and then back to the right in countries like Poland, the United States, and the United Kingdom, cultural conflicts, destructive referendums such as Brexit, social polarization, or the disruption of global norms, all these are symptoms of a kind of “disease”: The consensus on “appropriate” social, political, and economic norms that dominated from the 1980s to the period of the global financial crisis has collapsed.
The COVID-19 pandemic has exacerbated this anxiety and reignited the latent fluctuations in inflation.
Future Uncertainty
If the Democratic Party wins or China is committed to a strong pace of structural reform, will the uncertainty be less obvious? This is debatable. But one thing is already clear: the era of low volatility has come to an end. An outstanding question is how destructive these factors will be. Politics, geopolitics, climate, healthcare, and our responses through trade, fiscal, monetary, or military means all play a role.
Future Outlook
We believe that the future will neither be characterized by persistent deflation nor persistent high inflation, but rather a coexistence of both: a world with high real interest rate fluctuations, affected by exogenous shocks that neither central banks nor investors can predict or estimate. The same is true of risk premiums and inflation.
However, in the long run, deflation will prove to be a stronger force, as the disintermediation of labor and capital will redefine the roles of both and unleash a productivity surge. But this will still take several years. Meanwhile, investors will keep arguing and reach no consensus except for uncertainty: There have been three major events within five years; get ready for more events.
We have not yet withdrawn from the world of low interest rates. Both 2% and 5% interest rates are possible.
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