The U.S. has witnessed near historic inflation since the economy began to re-open in 2021 following the COVID-19 lockdowns, as seen in the chart below.

There have been several factors put forth to explain this inflation outburst and its persistence, which have been difficult for policymakers to disentangle and have led to an active debate by leading economists. Some analysts have focused on the importance of supply chain constraints, while others point to demand as driving the jump in inflation.

Meanwhile, some economists argue that a combination of supply and demand factors are necessary to generate the inflation we are currently witnessing. Our work belongs to the last camp.

“Many consumers are cutting back on discretionary dining and seeking cheaper options on everyday essentials like gas and groceries, while others are delaying purchases altogether, especially for big-ticket items,” said a recent industry intelligence report by Morning Consult.

This is the third rocky year in a row for big retailers. The pandemic was, of course, a consumer earthquake. Home confinement, telecommuting, transportation stoppages, and hotel, movie theater, bar and restaurant closures all changed the way Americans and everyone else spent their money in 2020. For starters, they spent a lot less.

There were some winners like Netflix, Peloton, Zoom and Amazon, and some clear losers like airlines, hotels and restaurants, but the retail hangover is proving hard to shake.

Inflation, rising interest rates and crude prices have caused market declines in both equity and bond markets globally. There is no shortage of opinions linking high inflation/interest rates with low market levels.

But is the negative relationship as straightforward as we think? Could there be room for nuance? The best way to answer these questions is to study past episodes of inflation and crude flare-ups and their impact on markets. Let’s start with inflation.

We analysed data on the US stock market and its correlation with CPI inflation stretching across 53 years, which included the dreadful 70s when the oil price shock and stagflation torpedoed economies. Inflation averaged 7.8 per cent between 1970 and 1982.

U.S. consumer price inflation fell but was still at nearly a 40-year high of 8.5% in July – down from 9.1% in the prior month – and is expected to average almost 4% in 2023, according to analysts polled by Reuters.

The outlook is starkly worse in energy-importing Europe where Russia’s invasion of Ukraine has led to sky-rocketing energy prices that look set to keep on accelerating as Moscow retaliates against European sanctions by restricting gas flows.

Eurozone price growth is now set to hit double digits as measures taken by Germany and other countries to soften the cost-of-living hit for consumers start to expire, the Bundesbank warned this week. 

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