Under the new approach, the Fed will target higher inflation in order to make up for years of subdued inflation. Previously, the Fed would only target forward-looking inflation expectations, ignoring past inflation. Fed officials moved towards a new approach that targets “inflation symmetry” within the business cycle, i.e., periods of above target inflation are expected to offset periods of below target inflation. Moreover, the US Federal Reserve (Fed) is currently changing its monetary policy reaction function, i.e., the responsiveness of nominal policy rates to changes in inflation and output. This places a cap on wage growth and limits the prospects of inflation acceleration.
Chances of a significant “inflation scare” are slim due to the persistence of secular deflationary forces, including globalization and the structural gap in the bargaining power between labour and capital. Four reasons underpin our position.įirst, major central banks are unlikely to reverse recently implemented accommodative measures. In our view, the Goldilocks scenario is likely to continue well into 2020. Downturn fears suddenly turned into a condition that is “just right.” But can the sweet spot continue for long? The index tracks investor sentiment about economic activity. This can be observed in the sharp rebound of the Sentix global aggregate economic index from a position that was negative and deteriorating to one that is positive and improving. Since then, the economic expansion cycle gained further support with almost all major asset classes rallying. There is little doubt that at some point in Q3 last year global recession/deflation fears were reversed by more aggressive monetary policy easing and positive developments in trade negotiations. Goldilocks is therefore a comfortable scenario of persistent growth prospects with low downside risks. This is relevant as policy responses to inflation pressures coming from overheated economies have often caused both recessions and bear markets. In other words, an economy that is hot enough to propel or maintain earnings growth, but cool enough to keep monetary authorities from tightening policy. What is the sweet spot for global economic conditions? Like Goldilocks in the old British tale, most investors prefer an economy that resembles a good porridge, neither too hot nor too cold, but “just right.” In macro terms, this translates into an ideal scenario of moderate growth with high employment and low inflation.
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