Over the past two years, a significant disinflationary impulse has dampened nominal activity around the world. The slowdown in real growth in that period has been modest – global real GDP expanded at a 2.7% annualised pace, right in line with our potential growth estimate. However, commodity prices and producer prices declined sharply, which pushed consumer price inflation (CPI) down to historic lows outside of a recession. All collapsed at their fastest pace in decades, excluding the Global Crisis (Figure 1). This in turn, has weighed more heavily on real activity than we had initially expected. But as the disinflationary impulse fades, both nominal and real growth should normalise.
Figure 1 Oil and global producer pricing
In effect, the disinflation impulse reflects a significant positive supply shock in commodities (oil, specifically), reinforced by a somewhat larger than initially assumed negative demand shock. These shocks produced a dramatic rotation in regional and sectoral performance. The emerging markets and commodity producers weakened significantly, with some countries (Brazil and Russia) experiencing deep recessions. Income shifted away from corporates and toward households as inflation slid sharply. This boosted consumption, primarily in the developed markets, while global capital spending stalled.
With the supply shock looking to have stabilised and the demand shock fading, the pricing complex should normalise. We expect producer price inflation to move back into positive territory and consumer prices to rise 2.5% in the coming year – a return to its 2013-14 pace. The pickup should lift corporate profit growth and, in turn, boost business equipment spending and help return the global economy to more trend-like growth. It should also lift inflation expectations, adding to stimulus by lowering real interest rates and further reinforcing the fading of the demand shock. Demand shocks are also fading as prior developed market fiscal tightening has turned neutral (Lupton and Saijid 2016).
Figure 2 Global PPI and CPI
The latest signs are that this rotation in pricing, profits, and real activity is underway. After bottoming in February this year, global producer price inflation has surged to 3.5% annualised in the six months to August – its fastest such pace in five years. Global consumer prices have also accelerated from their February lows and are up 2% annualised in the six months to August (Figure 2). Inflation expectations remain depressed but there are some hints of a firming in the US. The early readings also show a momentum-shift upward in corporate profit growth. For now, the acceleration is from large declines to stability, but we forecast global corporate profits advancing 5-10% in 2017 as nominal GDP accelerates. The leading signs of improvement align with recent indications of a pickup in capital spending. If these trends continue, the fading disinflationary shock will be a key foundation for extending the life of the expansion in the face of gradual Fed hikes over the coming year.
A disinflation impulse that did real damage
When commodity prices began tumbling in 2014 (and kept tumbling through to early 2016, with some ups and downs), we highlighted an identification problem. To the extent that this tumble reflected supply developments, it would boost global growth. By contrast, large price declines from demand weakness often signal impending recession. There were clear signs that both forces were at play – big increases in the production of energy and other commodities at same time that the emerging market credit boom was starting to deflate. In the event, global GDP prices (i.e. the ‘deflator’) decelerated sharply in 2014 and 2015, but real GDP growth also stepped down (Figure 3).
Figure 3 Global real GDP and deflator
We had forecast the commodity supply shock would induce an income rotation toward higher marginal propensity to consume households, which would more than offset the concentrated hit to business spending. However, the hit to business equipment spending, combined with the emerging market demand shock, was larger than we had anticipated. Real consumer spending did accelerate, but this was more than offset by a much sharper deceleration in real fixed investment (Figure 4).
Figure 4 Global real GDP contributions
It now appears that, while a significant share of the collapse in commodity prices owed to a positive supply shock, headwinds to growth across much of the emerging markets and parts of the developed markets constituted a larger negative demand shock than we had anticipated. This demand shock appears to have been concentrated in the goods sector, as global services provided a much-needed buffer to the slide in goods production over the past two years (Figure 5).
Figure 5 Global Purchasing Managers Index
Overall, global nominal GDP slowed to a weak 4% annualised pace in the year ending 1Q16 from a 5.8% average annualised rate from 2010 through to mid-2014. This is the weakest showing on record outside of a recession. The collapse in nominal growth resulted in a significant slide in corporate profits. Globally (on a GDP-weighted basis), earnings per share of listed companies have tumbled roughly 20% since mid-2014. In a recent report, we underscored the linkage between the profit cycle and the business cycle, noting that the recent decline in profit growth over the past two years is a rare outcome typically reserved for recessions (JP Morgan 2016). Not surprisingly, business equipment spending slumped (Figure 6).
Figure 6 Global corporate profits and equipment spending
The coming unwinding of disinflation
Initially the commodity price collapse drove the disinflation impulse. As commodity prices have bounced from their February lows, the pressure on the broad inflation complex is reversing. The most obvious imprint will be felt on CPI. We have long expected a jump in global CPI inflation but have been somewhat surprised that the rise has yet to materialise (Figure 7). We attribute part of this surprise to a lack of pass-through of the recent jump in oil prices into consumer energy prices.
Figure 7 Global headline inflation
However, the outlook still projects that global CPI will rise nearly a full percentage point over the coming months and the model tracking-error suggests the risks are skewed to the upside. The latest data suggest inflation is already starting to strengthen. Over the three months through August, the global CPI has advanced 1.8% annualised. This three-month pace is off a little from June, but is well above the 0.9% lows from earlier this year (Figure 8).
Figure 8 Global headline inflation