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European Stock Markets Performance 

European stock markets headed lower again Friday to cap a pretty downbeat week, with the major indices sliding about 2% over the five days. US markets snapped a three-day losing streak yesterday but are also heading for a weekly decline. Investors seem to be pausing for breath – lots of risks ahead after the liquidity-injection rally...liquidity trap coming? It looks decidedly risk-off this morning with the dollar firmly bid and crude oil sharply lower for a second day – the mood is changing from inflation risk to growth risk. 

  

Japan's Inflation Surge and Nikkei Decline 

The Nikkei fell sharply as inflation in Japan jumped unexpectedly to a 42-year high. The so-called core-core CPI, which is particularly watched by the BOJ, rose 4.3%, the biggest increase since June 1981. This ought to pressure the BoJ to do more to normalise policy but for now it seems to be sticking to the view that inflation will come down later this year. Even the possibility of the BoJ tightening a tad sent investors to take profits after shares in Tokyo recently hit the highest in 33 years. Meanwhile the yen fell to a fresh 7-month low against the dollar before trimming losses with USDJPY above 143.44. 

  

Eurozone Economic Indicators 

Eurozone PMI data this morning looks very weak – German manufacturing down to 41.0 vs the estimate of 43.5, services holding up much better but also coming down. No way that services can continue to drive things without manufacturing support. Meanwhile we have a deeply inverted yield curve – recession indicator – with the German bund yield curve the most inverted since 1992. More flash PMIs for the UK and US coming up later. 

  

Janet Yellen's View on US Recession Risks 

Janet Yellen, the US Treasury Secretary, said risks of recession in the US “have gone down – because look at the resilience of the labour market, and inflation is coming down”. I think this misses the point entirely – we are entering a new phase. Inflation is yesterday’s story – apart from in the UK – and we now enter the stagnation and recession phase. The risk regime is shifting from inflation to growth. That is not to say that inflation remains elevated – we are in a new inflationary paradigm, but don’t think central banks will throw every last basis point at getting core inflation down from 4% to 2%. 

  

Higher Inflation as the New Normal 

Inflation is going to be higher for longer. A more fragmented world means inflation is not about to come back down to 2% easily. Unless you are Argentina or Zimbabwe you cannot keep hiking forever – central banks will in the end need to accept, or at least tolerate, higher inflation as the new normal. Whether mandates are adjusted may be a matter of taste. In the words of Mike Tyson, everyone has a plan until they get punched in the mouth. 

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