In mid 2016, the global economy embarked on a regime of reflation that has been dominating market behaviour ever since then. This has constituted a simultaneous rise in real output growth, along with a rebound in inflation as commodity prices have recovered from their 2014-15 slump.
The result has been a sharp increase in nominal GDP growth in most of the major economies. As the secular stagnation theme has lost its potency for investors, a decline in the perceived risk of outright deflation has triggered a rise in breakeven inflation expectations in bond markets everywhere.
One of the most important questions for 2017 is whether this bout of reflation will continue. My answer, based partly on the latest results from the Fulcrum nowcast and inflation models (see first graph), is that it will continue, at least compared to the sluggish rates of increase in nominal GDP since the Great Financial Crash.
However, the nature of the reflation theme is changing. The term “reflation” does not necessarily imply that global inflation, or inflation expectations, will continue to rise very much from here.
A likely pattern in 2017 is that there will be upgrades in consensus forecasts for real output growth, but inflation will stabilise, and will not threaten to break above central bank targets in most advanced economies.
Equities and other risk assets would probably view this as a healthy mix of output and inflation components of national income, while bond markets would probably exhibit a stabilisation in breakeven inflation expectations, with real yields rising a bit. Read more