Emerging Markets | Monetary Policy & Inflation | US
Inflation Is Higher in the US Than Emerging Markets for the First Time
- By Dominique Dwor-Frecaut
- 4 min read
Summary
- For the first time on record, US inflation is above the emerging-market median.
- This reflects overly loose fiscal and monetary policies rather than the pandemic’s severity in the US.
- Such policies mean the US has had one of the strongest post-pandemic recoveries of major economies but faces a risk that taming inflation could engender a recession.
Market Implications
- The market is underpricing the policy tightening needed to lower inflation.
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Summary
- For the first time on record, US inflation is above the emerging-market median.
- This reflects overly loose fiscal and monetary policies rather than the pandemic’s severity in the US.
- Such policies mean the US has had one of the strongest post-pandemic recoveries of major economies but faces a risk that taming inflation could engender a recession.
Market Implications
- The market is underpricing the policy tightening needed to lower inflation.
US Inflation Is Above the EM Median
For the first time on record, US inflation is above the emerging-market (EM) median – and has been since Q1 2022 (Chart 1). Up to the pandemic, US inflation was closely tracking the developed-market (DM) median, which was below the EM median (I track 36 countries in this note).[1] This outperformance of US inflation reflects the US policy response rather than the severity of the US pandemic.
The US Pandemic’s Direct Economic Impact Aligns With Median Country
The pandemic’s impact on economic activity in the US has been near the median for my 36 countries, based on Google community mobility reports averaged over 2020-21. These measure the change in number of visits to residential, office, retail or leisure locations relative to January 2020.
Since the pandemic’s economic blow to the US nears that to the median country, higher US inflation is likely to reflect US policies.
US Fiscal Policy Normalization Lags Economic Normalization
US fiscal policy has been much more expansionary than that of either the median DMs or EMs.
Also, when adjusted for the business cycle, the International Monetary Fund still sees US fiscal policy as highly expansionary in 2022. This is because unemployment has quickly fallen below its long-term level, but fiscal policy remains abnormally loose when assessed against very low unemployment. In addition, the budget deficit is not falling as fast as, for instance, the Congressional Budget Office’s latest projections projected.
Fiscal policy is likely to remain expansionary at least until the next budget cycle in FY2023. A GOP Congress takeover in the November midterms could, however, see a marked policy tightening.
US Monetary Policy Is the Loosest of 36 Major EMs and DMs
The US monetary policy stance, measured by the policy rate deflated by the Consumer Price Index, is the loosest of my 36 DM and EM countries. DM central banks, including the US, have engaged in massive asset purchase programs and just started policy normalization. By contrast, EM central banks have been much more restrained with their balance sheet expansions and more proactive with normalization. This is reflected in a median real policy rate that is higher in DM than EM, though both remain negative.
Since the US has one of the highest inflation rates in my country sample, the Fed’s reactiveness has resulted in the real US policy rate falling well behind the EM and even DM median.
The US Recovery Is One of the Strongest of 36 Major EM and DMs
Unsurprisingly, with very loose policy settings, the US has had one of the strongest recoveries in my group of countries. That said, New Zealand, Korea, Chile, Israel and Taiwan have had stronger recoveries with lower inflation than the US.
Going forward, the risk is that the positive impact of US expansionary policies on growth could reverse because taming inflation will likely involve a recession.
Market Consequences
The US inflation surge is an outlier both in terms of US history and of large EM and DM economies. It reflects unusually loose policy settings, possibly because the pandemic hit the US during an election year. Because inflation has strong inertia, stabilizing the US economy is likely to require much more monetary policy tightening than markets currently expect.
[1] Through this note, EM countries are comprised of China, India, Indonesia, Korea, Malaysia, Singapore, Taiwan, Brazil, Chile, Colombia, Mexico, Russia, Poland, Hungary, Czech Rep., Israel, Turkey, South Africa. DM countries are comprised of US, Canada, Australia, New Zealand, Japan, UK, Germany, France, Italy, Belgium, Spain, Portugal, the Netherlands, Ireland, Switzerland, Sweden, Norway, Denmark.
Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)