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Signs of Immaculate Disinflation

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Stockholm (HedgeNordic) – Economists and investors have become increasingly optimistic about the possibility of achieving what some refer to as ‘immaculate disinflation,’ also known as a soft landing or a gradual reduction in inflation pressures without an economic downturn. The team at Nordkinn Asset Management has noted that developments and outcomes over the past weeks have arguably increased the chances of an immaculate disinflation process.

“Global policy rates are probably at, or close to, their peak – close to the ‘terminal rate’ in financial jargon,” Roger Josefsson, Head of Research at Nordkinn, writes in a letter to investors. “Indeed, financial market pricing is almost unanimously pointing towards an economic ‘soft landing,’” he emphasizes. From a U.S. perspective, this implies that by the end of 2024, inflation will approach its target of two percent. Furthermore, both demand and labor markets are expected to stabilize, as reflected in a GDP growth rate of around two percent and a monthly employment growth of around 100,000 jobs, as measured by NonFarm Payrolls. “If this plays out, the Fed should eventually be able to gradually reduce the FED Funds Rate towards its neutral stance,” writes Josefsson.

“Indeed, financial market pricing is almost unanimously pointing towards an economic ‘soft landing.’”

While the European economy mirrors the U.S. economy in some respects, it faces additional and significant challenges that make its trajectory less clear. Economic activity appears to be declining, with weakness in the manufacturing sector now spreading into the services sector. “There are indications that hiring intentions in both services and manufacturing sectors are falling,” observes the team at Nordkinn Asset Management. However, there are also positive aspects, such as rising consumer confidence driven by higher wage growth and lower energy costs, which should support private consumption.

According to a leading ECB Executive Board Member, Isabel Schnabel, this environment presents two critical questions for policymakers: The first question is “[…] whether the current slowdown will prove sufficiently strong and persistent to reduce underlying price pressures in a way that ensures a timely return of inflation to our target.” The second question facing policymakers is “[…] how fast the slowdown, should it persist, will succeed in reducing underlying price pressures.”

The first question pertains to the ongoing debate in financial markets about a hard versus soft landing. “To us, some retracing of labour demand should be expected, after the exuberant developments in the wake of consecutive supply shocks and policy-boosted demand,” writes Josefsson. “The key, in our view, is that wage growth is outpacing inflation and real income growth will, for the time being, serve to prop up domestic demand,” he continues. “Our current impression is that with demand continuing on a strong note, companies will be able to pass on also increased wage costs, effectively forcing the ECB’s hand. In every way, we believe this is also a valid description of the U.S. outlook.”

“…we believe that the interplay of high unit labour costs and surprisingly robust demand growth will indeed produce a situation where rates will need to remain ‘higher for longer.’”

Nordkinn’s answer to the second question relates to the first but involves a more fundamental discussion about possible structural changes to the economy. “Here, and in all honesty, we have very little additional information to offer,” says Josefsson. “Suffice to say, on some kind of operative time horizon, it is difficult to see how any of the drivers most often discussed would act to lessen inflationary pressures (over the coming 2-4 years).”

“Getting the answer to the first question right is of higher importance to us at Nordkinn,” concludes Josefsson. “While there is a risk of inflation proving transitory after all, we believe that the interplay of high unit labour costs and surprisingly robust demand growth will indeed produce a situation where rates will need to remain ‘higher for longer.’”

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Eugeniu Guzun
Eugeniu Guzun
Eugeniu Guzun serves as a data analyst responsible for maintaining and gatekeeping the Nordic Hedge Index, and as a journalist covering the Nordic hedge fund industry for HedgeNordic. Eugeniu completed his Master’s degree at the Stockholm School of Economics in 2018. Write to Eugeniu Guzun at eugene@hedgenordic.com

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