This Leading Indicator Suggests Inflation Might Finally Be About To Drop Off

This Leading Indicator Suggests Inflation Might Finally Be About To Drop Off
Stéphane Renevier, CFA

almost 2 years ago1 min

Credit impulse (blue line) represents the annual change in the flow of credit to households and banks as a percentage of a country’s economic output. When that flow of credit is growing rapidly, a lot of spendable money is created. And when there’s too much money for too few goods, prices rise – albeit with a lag of about 15 months (orange line). This is what we’ve seen since the Covid outbreak: major support packages increasing the pace at which credit flew to the private sector, creating inflation 15 months later – i.e. today.

Credit impulse is now falling sharply, but even that isn’t necessarily a good sign. While it may help reduce inflationary pressures, bear in mind that there are other factors at play – namely supply disruptions, caused first by the pandemic and now by the war in Ukraine. What’s more, it doesn’t bode especially well for economic growth, which tends to benefit from a positive credit impulse: more money means consumers spend more and companies earn more.

Still, if the relationship holds and a falling credit impulse leads to slower growth and lower inflation down the line, there’s one asset that should benefit quite nicely: long-term government bonds, like the iShares 20+ Year Treasury Bond ETF (ticker: TLT, expense ratio: 0.15%). And given how overwhelmingly negative sentiment is around their outlook, you might be onto a quite interesting contrarian trade there…

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