We continue to believe that the 10-year US inflation breakeven will rise to 3% by the end of 2022 (and c.2½% by the end of 2021). Our inflation concerns are predominantly US-focused. 

What factors could cause inflation expectations to rise further? 

Policy: Our aggregate US policy indicator is very loose and we think it will remain that way until inflation rises. The big change from the post-GFC period is that in the US there is no desire for fiscal austerity (in fact, quite the opposite), banks do not have to de-lever and we think the Fed may allow inflation to rise to 2.75% to 3%. If policy is loose enough for long enough, we will get inflation in the product market and ultimately the labour market as well. 

Money supply: Money supply leads inflation by two to three years. This time around, excess liquidity has gone into deposits (which can be spent) more than banks’ reserves.  

Many of the disinflationary forces of the past decade have diminished, with reduced globalisation, rising commodity prices, much of the impact of ‘price discovery’ already seen (with a third of UK retail sales now online), and much of the impact of regulation on European inflation behind us (especially in telecoms and financial services).  We can also see CPIs more accurately reflecting higher house prices. As millennials account for a growing share of the electorate, we think that politicians will increasingly focus on raising minimum wages (in the US, we estimate a $15 per hour federal minimum wage would add c.5% to US wage costs).  

We believe that the only way to stabilise government debt to GDP and exit this crisis with sufficiently low levels of unemployment is to drive real bond yields lower (to c. -2%). Austerity and default are not sustainable options, but partially inflating the debt away is. The situation that led to stagnant prices in Japan is unlikely to be repeated in the US or the EU.