Investment managers must study developments in geopolitics, energy supply, demographics and sociology when predicting inflation trends, rather than jumping to simplistic conclusions.
Over the past four years, major structural trends that influence long-term prices have simultaneously reversed. Since 2021, they have provided a tailwind for inflation and should continue to do so for the next 10 or 15 years, after having been a powerful headwind for inflation for 40 years.
The more widespread and consensual analysis based on the study of the business cycle concludes, on the contrary, that inflation is likely to return sustainably to the 2 per cent target in the major economically advanced areas, even if president Donald Trump's tariff policy temporarily weakens this reading, for the US at least.
Does the business cycle provide the right perspective for anticipating long-term price dynamics? Jerome Powell told us in 2021 that inflation — which he had not seen coming — would only be temporary. The disruption of production chains caused by Covid-19 and its lockdowns, subsequently aggravated by energy supply disruptions linked to the war in Ukraine, would be resolved and allow the economy to return to its sacrosanct 2 per cent inflation.
The Fed chairman was, however, somewhat mistaken about the extent of the price increase, which reached almost 10 per cent, and the duration of the inflationary surge. In the summer of 2024, as US inflation was returning to its target, Mr Powell reiterated the same analysis as that of 2021, without adding the slightest reference to the impact of more structural forces.
The Trump shock
Four decades of disinflation have created a strong belief in the permanent ability of the economy and central bankers to produce decent growth without inflation. The ‘Trump shock’, beyond its inflationary effects which should be concentrated in the short term in the US, will above all have recessive effects, and therefore disinflationary effects.
This is in any case the conviction of those who rely on the study of the short-term economic cycle to anticipate changes in the inflation regime, a conviction reinforced by the fact that foreign products that can no longer reach the US, their traditional customer, will have to be sold cheaply elsewhere. They generally add to this reading the deflationary effects of artificial intelligence which, via massive layoffs, will soon make themselves felt and conclude that inflation is no longer an issue.
This approach has its merits, of course, and cannot be dismissed out of hand. But this type of analysis, based exclusively on the short term, is rarely effective in anticipating the future inflation regime. We had a potential glimpse of this with the erroneous vision of the central bankers in 2021. Another, more effective one, occurred during the era of Alan Greenspan — the father of modern central banking — who spoke of a “conundrum” to express his lack of understanding of very low inflation and interest rates in the second half of the 1990s. In both of these emblematic cases of poor judgment or misunderstanding, the mistake was probably to focus on the short term and to neglect the major structural forces “above” the economic cycle.
Five major forces
In the 1990s, as had been the case since the year 1980 which marked the peak of US and European inflation after 15 years of cyclical price increases, at least five major forces combined to limit inflation. The first was a major demographic trend which, by increasing the weight of savers in the economy of the main countries every year, increased the capital available for investment and productivity gains.
The second force was that of a peaceful geopolitics very favourable to business, which amplified the development of globalisation that began at the end of the second world war and allowed Ricardian disinflation.
The third was strong and continuous growth in energy production, which helped economic growth after two oil shocks with stagflationary effects. The fourth force was a sociology very favourable to economic efficiency after the disgust caused by 15 years of inflation, and the fifth was a Chinese age pyramid that flooded the world with cheap products made by a young and plethoric workforce.
These major trends have quashed inflation, until the post-Covid economic reopening provided the inflationary spark that the simultaneous reversal of these five forces is likely to fuel for many years to come.
Let's take them in order: demographics that now reduce the proportion of savers in the population; geopolitics that are tense on all sides and proving less and less conducive to disinflation through trade; energy that is becoming more expensive as a result of the energy transition and geopolitical tensions; a sociology increasingly alien to the value of work; and, finally, the absence of an organised substitute for China to influence global wages.
Wouldn't these long-term factors be more naturally suited to anticipating medium-term inflation than an analysis of the short-term economic cycle? The inflation we are talking about peaked for the first time at the end of 2022 in Europe and the US. The second wave has probably already begun in the US, and it is dangerous to believe that it will be contained there or that it will not be followed by other waves.
Long-term structural trends are indeed taking hold in all advanced economies and beyond, such as Mr Trump's tariffs, which are a consequence and an acceleration of the reversal of the structural geopolitical and commercial trend towards an inflationary deglobalisation.
This almost deterministic approach to inflation is neither conventional nor consensual, but its inherent rationality seems sufficiently compelling for us to incorporate it, at least to some extent, into our investment strategy. The structural return of inflation would have such effects on the valuation of all assets that such an approach should not be dismissed out of hand.
Frédéric Leroux, global manager at Carmignac
