The global economy has been sailing in uncharted waters for some time now. The huge asset bubble that led up to the financial crisis of 2007-2008 has in some sense never really deflated despite all of the pain in the stock market and housing sector, as the Fed and other central banks have pumped up liquidity to historic levels so all the bad loans etc. that underpinned the crisis were never really washed out.

The Fed and the central banks certainly averted the downward spiral of the 2007-2008 liquidity freeze, but to date seem to have had very little success in their efforts to “juice” the global economy. According to an October 18th report from multi-asset research firm Source, low commodity prices may be masking the stirrings of real economic growth.

Source analysts Paul Jackson and András Vig suggest that a careful analysis of recent economic data indicates that core inflation is actually beginning to pick up in both the U.S. and Europe.

Fears of deflation are greatly exaggerated, core inflation up

core inflation

Jackson and Vig argue that, based on their analysis, “…fears of deflation are greatly exaggerated; if anything, core inflation has been creeping up during 2015.”

The analysts do note there is conundrum in that headline inflation is trending slightly down, and core CPI is apparently not following headline inflation lower is not clear, especially given commodity prices have continued to drop. They throw out possible explanations such as tightening labor markets and extremely loose central bank policies finally kicking in to produce an uptick in inflation. They also highlight that Sweden’s measure of core inflation has risen from 0.5% in January to 1% in September.

core inflation

core inflation

Moreover, it seems clear that price movements over the last week suggest global markets remain more focused on headline instead of inflation (Figures 3 and 4). Note that bond yields are down (the 5y/5y forward inflation rate has slipped around 10 bps in the last week to 2.07%), and stock markets have been led by growth sectors such as technology and healthcare that typically reward investors when discount rates drop and by heavily indebted sectors (such as utilities).

Of interest, gold is also up for the week, although more likely related to dropping bond yields and the USD, and not inflation fears.

Jackson and Vig conclude their report by suggesting that if core inflation rates are actually ratcheting up, this means that “medium to long term rates would need to adjust upwards”, gold is probably going to fall and stock markets may also get at least a short-term bounce.