US inflation has been coming down steadily and many market participants believe this could lead to a “soft landing” scenario where economic growth continues, boosting investment returns. But Blitz says the nature and reasons for the drop in inflation are such that a recession is more likely.
He says the recent inflation should be divided into two categories: the inflation caused directly by the imbalances resulting from the restrictions of the pandemic era, such as damage to supply chains, and the inflation that is more embedded.
As a result, the decline in inflation needs to be divided into similar categories, he said.
The principal measure used by the US Federal Reserve to understand the different types of inflation is “Services Ex Rent” and Blitz says inflation in this area has been declining since the third quarter of last year.
This measure may be one which excludes the more temporary pandemic induced issued in the economy, because the services sector should be less vulnerable to supply chain issues.
Blitz says: "There is disinflation from Covid-related distortions and there is disinflation signalling weak growth. The Fed, at this point, is indifferent and will hold off hiking in June – their long-awaited passive widening of funds to inflation has begun.
"This is a particularly critical point in the cycle because the long lag between inflation and growth pins the low for inflation from last year’s negative first half for GDP around now. In other words, if there is a reacceleration of growth, we could be in and around the low point for inflation until perhaps August or September. My bias, however, remains with recession beginning sometime mid-year and, in turn, pulling inflation down from these levels over time."
The other factor Blitz believes will contribute to the swift decline in economic growth and inflation is the recent regional banking crisis in the US.
His view is this will make banks more cautious on lending, and this reduces both the supply and the velocity of money in the economy, which would usually reduce the level of both inflation and growth.
Roger Aliaga-Díaz, chief economist for the Americas at Vanguard, says investors and central banks are in a stand-off about the direction of interest rates, but even if it proves to be the market that is wrong, there are returns to be made.
Rock and a hard place?