Bond markets and DM central banks remain convinced that inflation will return to the low and stable environment that existed prior to the pandemic. Indeed, headline inflation has declined considerably from the peak hit after the world economy “re-opened” earlier this decade.
However, inflation has stalled above the average levels recorded in the prior two decades, especially domestically-generated inflation (proxied by service sector CPI). Crucially, there is little economic slack outside the weakest (and smaller) DM countries, and no slack in the still-robust U.S. economy.
The implication is that if our constructive global economic outlook pans out, then inflation will remain sticky and prone to firm over time. Bond markets and central banks are not expecting such an outcome, despite being persistently too optimistic on inflation in recent years.
