Globalization is under pressure on several fronts. Two years after the outbreak of the COVID-19 pandemic and amid growing geopolitical unrest, a long time of disinflationary headwinds have reversed. Many multinational firms have taken steps to handle the associated disruptions to their expansive and hyper-optimized but ultimately fragile global value chains.
These institutions are refocusing Prioritize availability over cost optimization. This process manifests itself in 3 ways:
- Regionalization: Moving supply chains closer to key markets.
- Nearshoring: Relocation of supply chains to neighboring production centers.
- Reshoring: Partial reversal of the cost-saving offshoring of previous a long time.
Inflation is a key consequence of those changing priorities. Restructuring dispersed global manufacturing centers into redundant regional supply chains requires greater capital investment and resource expenditure in every thing from logistics to management. Such improvements cost money, and consumers will ultimately pay higher prices in return for more reliable supply chains.
Furthermore, the globalization process and the increasingly efficient allocation of resources in recent a long time depend upon the geopolitical stability of the post-Cold War era. The collapse of the Soviet Union and China’s entry into the World Trade Organization (WTO) enabled cost convergence between once segmented commodity and labor markets. This led to disinflationary pressures in advanced economies. In retrospect, the Iron Curtain was a big obstacle that denied developed economies wealthy grain harvests and energy resources.
But as cracks form along geopolitical fault lines, latest obstacles could emerge that disrupt global trade. The “peace dividend” of the last 30 years could proceed to dwindle: blockades, embargoes and conflicts could lead on to costly detours in the provision chain.
An inflation “paradigm shift” restricts monetary policy
Against the backdrop of the Russia-Ukraine conflict and the continuing pandemic-related disruptions, Agustín Carstens, the General Director of the Bank for International Settlements (BIS), recognized that “Structural factors that have kept inflation low in recent decades may weaken as globalization declines.” He continued:
“Looking further into the future, some of the structural disinflationary winds that have been blowing so strongly in recent decades may also be easing. In particular, there are signs that globalization may be declining. The pandemic, as well as changes in the geopolitical landscape, have already begun to cause companies to rethink the risks associated with sprawling global value chains. And regardless, the increase in total global supply caused by the entry of some 1.6 billion workers from the former Soviet bloc, China and other emerging economies into the effective global labor force may not be repeated on such a significant scale for a long time. If the retreat from globalization accelerates, it could help restore some of the pricing power that companies and workers have lost in recent decades.”
In Carstens’ framework, a paradigm shift in inflation can be a paradigm shift in monetary policy. Thanks to the disinflationary effects of globalization, major central banks had considerable scope for unconventional monetary easing – printing money. Renewed inflationary pressures could reverse this dynamic. Rather than applying quantitative easing (QE) in response to virtually all downward shocks, central bankers would want to calibrate future support to avoid increased price pressures.
Yield curves predict monetary policy somewhat than recession
Despite these changing circumstances, each the European Central Bank (ECB) and the US Federal Reserve maintained their rate of interest policies well into the supply-driven rise in inflation. The ECB’s monthly bond purchases totaled €52 billion in March 2022, because the Eurozone’s Harmonized Index of Consumer Prices (HICP) reached 7.5% year-on-year (y-o-y). When the Fed slowed QE inflows in February, personal consumption expenditure (PCE) was already at 6.4% year-over-year. Despite QE’s role in suppressing long-dated bond yields, ECB purchases will fall to 2022 40 billion euros in April, 30 billion euros in May and 20 billion euros in Junebefore stopping “sometime” later.
ECB Asset Purchase Program (APP) and Pandemic Emergence Purchase Program (PEPP)
QE programs have anchored long-term global rates of interest and co-movement between European and US long-term yields. Lael Brainard of the Fed’s Board of Governors acknowledged the power of foreign QE to drive down long-term U.S. bond yields. Thus, the Fed’s expectations of rising short-term rates of interest within the face of ongoing quantitative easing abroad contributed to the inversion of the yield curve for US Treasury bonds with a maturity of 5-30 years.
Vineer Bhansali, the CIO of LongTail Alpha and creator of , also noted how politics affects the yield curve. Since central banks can influence all points of the curve through QE, the The shape of the yield curve reflects the political outlook somewhat than the likelihood of a recession. As Bhansali said:
“The first and most important signal that the Fed has distorted is the shape of the yield curve. In particular, the inversion of the yield curve is considered by market participants to be a fairly good indicator of recessions. Historically, that is how it is. Right now the Fed owns so many Treasuries that it has the power to shape the yield curve the way it wants.”
To complement Bhansali’s framework, an inverted yield curve includes the expectation that rate of interest increases will slow the economy as inflation falls and disruptions ease, freeing central banks from policy constraints – an approximation of the pre-2020 “old normal” – that lowering rates of interest can be a hurdle for renewed quantitative easing to suppress long-term yields.
Conversely, a change within the inflation regime, driven by a more fragmented world with scarcity-induced reflation, requires a reversal of balance sheet expansion or quantitative tightening. The Fed’s forecast of the way it would scale back its balance sheet – at $95 billion per thirty days – exceeded the expectations of many bond traders.
Scenarios for reducing the Fed’s balance sheet, pace somewhat than change in composition
Expansive supply chains drive inflation (and inflation policy).
As geopolitical instability disrupts the once efficient allocation of resources, the relative peace and prosperity of the last 30 years is being reassessed. Could the shortage of major power rivalries in recent a long time be the exception somewhat than the rule? And if the atmosphere continues to deteriorate, what’s going to that mean for today’s globalized value chains?
This framework suggests the potential for supply-led inflation somewhat than disinflation. Further unrest could fuel a deglobalization strategy of regionalization and provide chain retrenchment that drives up inflation. Still, a less expansive supply chain can profit from renewed expansion once disruptions end and inflation falls.
From a market perspective, current bond yields in developed countries cannot fully compensate investors if markets proceed to fragment. Carstens’ theory of an inflation paradigm shift resulting in a monetary policy paradigm shift implies significant risks for long-dated bonds, assuming a worsening geopolitical outlook and further supply chain disruptions.
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Photo credit: ©Getty Images / Thomas-Soellner
