Disinflation is a greater force right now than inflation

Reuters

2 days ago

ORLANDO, Florida, June 4 (Reuters) - Investors, consumers and policymakers may justifiably fear the specter of tariff-fueled inflation later this year and beyond, but it's powerful global disinflationary forces that are weighing most heavily right now.
The OECD said on Tuesday it expects collective annual headline inflation in G20 economies to moderate to 3.6% this year from 6.2% last year, cooling further in 2026 to 3.2%.
But the United States is an "important exception," the OECD argues, and it sees inflation there rising to just under 4% later this year and remaining above target in 2026.
While annual PCE consumer inflation in the U.S. cooled to 2.1% in April, the slowest rate in four years and virtually at the Fed's 2% target, consumer inflation expectations are the loftiest in decades. The Fed has paused its easing cycle as a result, and U.S. bond yields are higher than most of their G10 peers.
Economists at Goldman Sachs share the OECD's view that U.S. inflation will pick up to near 4% this year, with tariffs accounting for around half of that. Many others also agree that the U.S. appears to be the exception, not the rule.
The world's next two largest economies, China and the euro zone, find themselves trying to stave off disinflation. Deepening trade and financial ties between the two may only intensify these forces, keeping a lid on price increases.
Annual inflation in the euro zone cooled to 1.9% in May, below the European Central Bank's 2% target, essentially setting the seal on another quarter-point rate cut later this week. More easing appears to be in the cards.
As economists at Nomura point out, inflation swaps are priced for inflation undershooting the ECB's target for at least the next two years. This, combined with weakening growth due to U.S. tariffs and disinflationary pressure from China, could force the ECB to cut rates another 50 basis points to 1.5% by September.
China's war on deflation is, of course, well-known to investors, but it has appeared to slip off their collective radar given how protracted it has become.
The last time annual inflation in China eclipsed 1% was more than two years ago, and it has remained near zero, on average, ever since. China's 10-year bond yield remains anchored near January's record low below 1.60%, reflecting investors' skepticism that price pressures will accelerate any time soon.
They have reason to be doubtful. Deflation and record-low bond yields continue to stalk the economy despite Beijing's fiscal and monetary stimulus efforts since September. And punitive tariffs on exports to the U.S., one of its largest export markets, are generating massive uncertainty about the country's economic outlook moving forward.
This is where the exchange rate becomes important. On the face of it, Beijing appears to have resisted mounting pressure on the yuan thus far, with the onshore and offshore yuan last week trading near their strongest levels against the dollar since November.
But when considering the yuan's broad real effective exchange rate (REER), an inflation-adjusted measure of its value against a basket of currencies, the Chinese currency is the weakest since 2012. Robin Brooks at The Brookings Institution reckons it may be undervalued by more than 10%.
With China's goods so cheap in the global marketplace, China is essentially exporting deflation. And the yuan's relative weakness could put pressure on other Asian countries to weaken their currencies to keep them competitive, even as the Trump administration potentially encourages these governments to do the exact opposite.
Countries in Asia and around the world, especially in the euro zone, may also be nervous that China could dump goods previously bound for the U.S. on their markets.
If anyone wants confirmation that the "tariffs equal inflation" view is too simplistic, they got it this week from Switzerland, where deflation is back and potential negative interest rates may not be far behind.
True, Trump's threatened tariffs could throw everything up in the air. But the Swiss example is a warning to markets and policymakers that global disinflationary forces may be spreading.
(The opinions expressed here are those of the author, a columnist for Reuters)