Sandrine Soubeyran
- Tight labour markets make reducing inflation a challenge for central banks.
- Goods inflation has collapsed, after demand switched to services after Covid, helped by near full employment.
- The bear inversion of the yield curve has prevailed in 2023, and into 2024 – often a signal of a recession, and in contrast to expectations of a gentler, soft (economic) landing.
What are the current challenges for central banks in trying to reduce inflation?
Fighting inflation has dominated G7 central bank agendas in 2023 and continues into 2024, as central banks – with explicit targets – have tried to return inflation towards 2%. Despite most major economies generally avoiding a full-blown recession, tight labour markets, declining savings ratios, and higher energy prices have made this effort challenging, with “easy” disinflation gains now complete.
Tight labour markets and sticky core inflation in services proved the biggest challenge for central bank inflation control. This phenomenon is evident in most G7 economies, where labour markets have remained tight due to shortages, and are close to historic lows, though this appears to be easing more recently. In the US, the unemployment level had stayed unchanged at 3.7% since November 2023, but rose a little to 3.9% in February 2024. The soft landing in the labour market, at near full employment, with wage growth high, despite stabilising, helps explain the US Federal Reserve (Fed) policy pause since Q4 (i.e., its decision to maintain rates ‘higher-for-longer’) and more recently, caution on early pivots.
Similar to the US, UK wage inflation remains high, despite easing at 6.2% year-on-year in Q4, and headline inflation falling to 4.0% year-on-year in January. Unemployment has also been low, after being revised down by the UK’s Office for National Statistics (ONS) to 3.8% in December. High wage inflation continues to drive higher UK services inflation.
In the Eurozone, wages have been growing by about 5.0% on average, underpinning continued high demand for services and creating a risk of second-round inflation effects, if wage bargaining adapts further to higher inflation rates. This has been propping up services inflation, which despite being lower at 4.0%, remains close to its peak of 5.5%.
Most of the G7 countries, including the Eurozone (see chart), has seen goods inflation collapsing, as demand switched to services and manufacturing activity contracted, with related declines in industrial production, investment and international trade in goods.
Goods and services inflation (%)
Higher energy prices since January, due to supply cuts and mounting geopolitical risks, have also hampered central banks’ efforts.
As a result, most G7 central banks still caution of early pivots and do not expect to meet their inflation targets before 2025.
What is the data telling us about the current inverted yield curve?
As shown in the chart below, the bear inversion of the yield curve prevailed in 2023, and into 2024, as short-term government bond yields have been higher than their longer-dated equivalents – often a signal of a recession, and in contrast to expectations of a gentler, soft (economic) landing. A soft landing would imply a very mild, or no recession, and a return to growth.
Japan remains the exception, with its yield curve constrained by the Bank of Japan’s yield curve control policy, despite some speculation of a change in monetary policy.
Slope of G7 yield curves
In a higher yield world, income and carry optimisation may supplant duration as key factors.
Sandrine Soubeyran
Yields have adjusted to the notion of higher-for-longer rates – a reversal from the move seen in the summer and in Q4 2024, when the peak in interest rate rises appeared close and G7 government bond yield curves disinverted, as a result.
Who is feeling the pain the most from the bond-market sell-off?
Investors needing to hold long duration bonds (such as asset owners, like pension funds) would have incurred negative returns since January 2024, as discussed in our Fixed Income Insight Reports (Fixed Income Insights | LSEG). Like for much of 2022-2023, duration has been investors’ enemy, with the long end repricing to higher policy rates for longer. In a higher yield world, income and carry optimisation may supplant duration as key factors.
Duration have been investors enemy in 2023, like in 2022…
Sandrine Soubeyran
Q: Are we looking at a higher for longer scenario in terms of interest rates?
Although central banks, globally, were successful in reducing headline inflation in 2023, inflation remains above target in most jurisdictions with evidence of labour shortages, and hoarding, and wage bargaining adapting to higher inflation rates.Therefore, market fears of a ‘higher-for-longer’ policy rate scenario in global government bond markets has become the dominant narrative, as 10-year yields rise to new highs, especially since the recent Middle East turmoil.
And, even if lower housing costs have kept US CPI inflation below 4% year-on-year, the Fed remains concerned about the current strength in the US economy and tight labour markets.
Q: Can you explain what’s behind the Global Investment Research?
The Global Investment Research team – or the GIR team as it is commonly known – is a client-facing research group, helping clients navigate financial markets. We publish insights on current market dynamics across regions and asset classes.
Our research, by way of monthly and quarterly reports, topical commentaries and deep-dive empirical research, and our presentations to clients and the investment world, contribute to research discussions in the investment community, and improve our engagement.
These are all freely available on the FTSE Russell website. For more information, please visit our research hub on Market Insights | LSEG and/or register to receive it directly in your inbox.
Disclaimer
© 2024 London Stock Exchange Group plc and its applicable group undertakings (“LSEG”). LSEG includes (1) FTSE International Limited (“FTSE”), (2) Frank Russell Company (“Russell”), (3) FTSE Global Debt Capital Markets Inc. and FTSE Global Debt Capital Markets Limited (together, “FTSE Canada”), (4) FTSE Fixed Income Europe Limited (“FTSE FI Europe”), (5) FTSE Fixed Income LLC (“FTSE FI”), (6) FTSE (Beijing) Consulting Limited (“WOFE”) (7) Refinitiv Benchmark Services (UK) Limited (“RBSL”), (8) Refinitiv Limited (“RL”) and (9) Beyond Ratings S.A.S. (“BR”). All rights reserved.
FTSE Russell® is a trading name of FTSE, Russell, FTSE Canada, FTSE FI, FTSE FI Europe, WOFE, RBSL, RL, and BR. “FTSE®”, “Russell®”, “FTSE Russell®”, “FTSE4Good®”, “ICB®”, “Refinitiv” , “Beyond Ratings®”, “WMR™” , “FR™” and all other trademarks and service marks used herein (whether registered or unregistered) are trademarks and/or service marks owned or licensed by the applicable member of LSEG or their respective licensors and are owned, or used under licence, by FTSE, Russell, FTSE Canada, FTSE FI, FTSE FI Europe, WOFE, RBSL, RL or BR. FTSE International Limited is authorised and regulated by the Financial Conduct Authority as a benchmark administrator. Refinitiv Benchmark Services (UK) Limited is authorised and regulated by the Financial Conduct Authority as a benchmark administrator.
All information is provided for information purposes only. All information and data contained in this publication is obtained by LSEG, from sources believed by it to be accurate and reliable. Because of the possibility of human and mechanical inaccuracy as well as other factors, however, such information and data is provided "as is" without warranty of any kind. No member of LSEG nor their respective directors, officers, employees, partners or licensors make any claim, prediction, warranty or representation whatsoever, expressly or impliedly, either as to the accuracy, timeliness, completeness, merchantability of any information or LSEG Products, or of results to be obtained from the use of LSEG products, including but not limited to indices, rates, data and analytics, or the fitness or suitability of the LSEG products for any particular purpose to which they might be put. The user of the information assumes the entire risk of any use it may make or permit to be made of the information.
No responsibility or liability can be accepted by any member of LSEG nor their respective directors, officers, employees, partners or licensors for (a) any loss or damage in whole or in part caused by, resulting from, or relating to any inaccuracy (negligent or otherwise) or other circumstance involved in procuring, collecting, compiling, interpreting, analysing, editing, transcribing, transmitting, communicating or delivering any such information or data or from use of this document or links to this document or (b) any direct, indirect, special, consequential or incidental damages whatsoever, even if any member of LSEG is advised in advance of the possibility of such damages, resulting from the use of, or inability to use, such information.
No member of LSEG nor their respective directors, officers, employees, partners or licensors provide investment advice and nothing in this document should be taken as constituting financial or investment advice. No member of LSEG nor their respective directors, officers, employees, partners or licensors make any representation regarding the advisability of investing in any asset or whether such investment creates any legal or compliance risks for the investor. A decision to invest in any such asset should not be made in reliance on any information herein. Indices and rates cannot be invested in directly. Inclusion of an asset in an index or rate is not a recommendation to buy, sell or hold that asset nor confirmation that any particular investor may lawfully buy, sell or hold the asset or an index or rate containing the asset. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional.
Past performance is no guarantee of future results. Charts and graphs are provided for illustrative purposes only. Index and/or rate returns shown may not represent the results of the actual trading of investable assets. Certain returns shown may reflect back-tested performance. All performance presented prior to the index or rate inception date is back-tested performance. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index or rate was officially launched. However, back-tested data may reflect the application of the index or rate methodology with the benefit of hindsight, and the historic calculations of an index or rate may change from month to month based on revisions to the underlying economic data used in the calculation of the index or rate.
This document may contain forward-looking assessments. These are based upon a number of assumptions concerning future conditions that ultimately may prove to be inaccurate. Such forward-looking assessments are subject to risks and uncertainties and may be affected by various factors that may cause actual results to differ materially. No member of LSEG nor their licensors assume any duty to and do not undertake to update forward-looking assessments.
No part of this information may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission of the applicable member of LSEG. Use and distribution of LSEG data requires a licence from LSEG and/or its licensors.