Charts of the Week: Inflation Still Holds the Key

The US economy Last week’s US economic data releases almost universally disappointed forecasters’ expectations and have more generally flagged a slightly higher probability of a recession outcome in the coming months. For example, both the manufacturing and services ISMs declined into contraction territory in April. Weaker employment growth and a small step-up in the unemployment rate also indicate that growth momentum may be flagging. An indicator of recession risk generated by the Sahm Rule has certainly been climbing to more worrying levels (see chart 1 below). For the record, that rule asserts that a recession has begun when the three-month moving average of the national unemployment rate rises by at least 0.5 percentage points relative to its low during the previous 12 months.

US economic momentum versus the rest of the world Looking more broadly at global developments, this week’s PMI surveys (published by S&P Global) suggested that economic growth picked up in April in most major developed and developing economies. Looking at momentum over the past three months, however, also reveals a noteworthy anomaly. Specifically, and in line with the messages above, the US economy has been losing momentum according to these surveys, while other major developed and developing economies have been gaining momentum (see chart 2).

Global inflation surprises One reason for these relative shifts in growth momentum could concern the starting position of each economy. Many major economies, including the euro area and UK, were either in, or close to, a recession toward the end of last year. In contrast, the US economy has experienced relatively robust growth momentum over the last few months and up until now. Another noteworthy takeaway, however, from the recent dataflow concerns the unexpected pick up in US inflation compared with elsewhere (see chart 3). This pick-up may have eroded purchasing power and tightened financial conditions (through its impact on interest rate expectations), thereby acting as a brake on the US economy relative to other areas.

Oil prices and US Treasury yields Another critical element in this discussion about growth and inflation is the oil price. That’s because oil price gyrations have played a big role in driving global inflationary pressures in recent years. And financial market participants appear to have noticed judging by the very tight correlation between the oil price and US Treasury yields over the last year or so (see chart 4). That oil prices have dropped back of late has accordingly been another factor driving the improvement in financial market sentiment in recent days.

Global supply chain pressures and inflation surprises An additional factor that’s worthy of mention in this discussion is global supply chain pressure. As measured by an index that’s calculated by the New York Fed, those pressures have also been a big driver of global inflation in the post-pandemic era. And even now, small shifts in the degree of easing or tightening of those pressures appear to chime quite closely with inflation outcomes (see chart 5).

Asian currencies Finally—and largely due to shifts in relative interest rate expectations—the US dollar has been strong for most of the year. This strengthening has adversely affected Asian currencies, which have, on average, weakened by 4.4% against the dollar so far this year. The degree of depreciation among Asian currencies against the dollar has varied, however, with the Japanese yen experiencing the most significant weakening, while the Indian rupee has shown relative resilience. Recently, there have been notable strengthening moves in the yen, spurring speculation that these were driven by intervention from authorities. Regarding the rupee, potential reasons for its continued resilience include India’s positive yield differentials with the US and sustained investor optimism about India's economic prospects, among other factors.