Inflation Surprise! (…Or Lack Thereof)

Perhaps one particularly surprising thing this year has been the lack of surprise – that is, upside surprise in inflation.  Last year central banks around the world were hiking interest rates and beginning to normalize balance sheets as sights were set squarely on upside risks to inflation.  But the inflation surprise indices show a clear drift to the downside.

Q2 hedge fund letters, conference, scoops etc

Today’s chart comes from the latest Weekly Macro Themes report, which talked about some of the reasons or drivers behind the global policy pivot theme that I’ve been talking about since the start of the year.

The chart shows the breadth of inflation surprises (i.e. the proportion of inflation surprise indices tracking above 0). Basically, most countries are seeing more downside inflation surprises.

Specifically what we’re looking at is the breadth or proportion of inflation surprise indexes which are tracking above zero.  The inflation surprise indices were created by Citi, and much like their more famous counterpart, the economic surprise indices, they track whether inflation data is surprising to the upside vs downside.

But so what if inflation is surprising to the downside?

Well, a couple of things.  Firstly it must be acknowledged that this also reflects a softer global growth pulse (and relatively muted action in commodity prices).

As a result, and in and of itself, lower inflationary pressures and downside surprises in inflation also mean central banks find themselves struggling to justify some of the tightening that was delivered last year.

Already we’ve seen a clear pivot by central banks across the world to easing.

As for markets, it certainly puts the action in bonds into perspective, with government bonds enjoying a ripper rally across the globe.  But it also sets in motion a self-correcting feedback loop: downside inflation surprises and central bank easing will likely put in place the conditions that will ultimately lead to future upside surprises in inflation.

For now, this theme of inflation downside surprises may have further to run, as the breadth indicator has not quite reached the cyclical lows seen in the past – and that is certainly something I will be watching for.

Article by Top Down Charts

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