Inflation at heart of our Outlook Forum
• We see price pressures to persist in 2022, mostly driven by the unusual restart dynamics. Eventually, we see a higher inflation regime than pre-Covid.
• U.S. consumer price index (CPI) jumped more than expected in October, bringing annual inflation rate to 6.2%, the highest level in three decades.
• Data from China this week is expected to show a further slowdown in economic activity. UK CPI will also be in focus.

Inflation was at the heart of debates among BlackRock portfolio managers at our 2022 Outlook Forum last week. Inflation is being driven by the unusual supply shocks tied to the restart. We expect these imbalances to resolve over the next year, but see inflation as persistent and settling at a higher level than pre-Covid. We prefer equities in such an environment, as we expect a more muted yield response to inflation than in the past. This should keep real yields low, supporting stocks.

The U.S. CPI rose more than expected in October. This caught markets off guard, but as we have argued previously we shouldn’t be surprised by surprising data given the unique nature of the economic restart. It shows how little is known aboutrestart dynamics. Although price rises are broad based, the mix of inflation shows the unusual restart dynamics at play. The run-up of inflation has been due to
supply bottlenecks coupled with unusually strong household spending on goodsrather than services. The shares of goods spending in the total personal consumption expenditures jumped to around 36%, the highest level in 15 years.
Prices of goods excluding food and energy – which had been in deflation for most of the past decade – have surged way beyond core services prices, reflecting the restart disruptions and shifts in spending patterns. See the chart above.
Participants at our 2022 Outlook Forum generally agreed: 1) that higher inflation will persist next year while spending on goods remains high and supply bottleneckscontinue, and; 2) this supply-demand mismatch should resolve as the restart plays through, supply comes back on stream fully and spending on goods switches back to services. As a result we are still broadly pro-risk headed into 2022.

The U.S. CPI revived expectations for the Fed to start lifting interest rates from near zero as soon as June next year. We think the broader market pricing of higher policy rates is overdone – both in how soon key developed market central banks may lift rates and how quickly they will do so.

Macro insights
Current supply constraints are among the most severe of the last 75 years – see the chart – and are largely behind the high inflation prints we have seen over recent months. This unusual situation of supply-driven inflation is creating confusion among policymakers and markets. The usual logic for central banks to lean against inflation early doesn’t apply.

Supply chain imbalances are the result of supply-related factors, including labor tightness, semiconductor shortages and transport bottlenecks. Extraordinary demand – fueled by goods consumption, accumulated household savings, rising capex and generous fiscal policy, particularly in the U.S. – is adding to supply pressures.

Demand looks set to remain robust in 2022, but we expect supply to gradually rise to meet demand as most bottlenecks dissolve and the powerful restart of economic activity runs its course. Large companies appear well positioned to manage through the disruptions thanks to their scale, preferential access to supplies, greater capital expenditure and pricing power.