For the better part of two years, the world has been largely experiencing disinflationary pressures as central banks hiked rates to bring inflation back toward target levels. We saw commodity prices fall as sovereign rates rose with tighter monetary policy, economic growth slowed globally, and US equity market performance concentrated around a small number of companies that were able to generate strong earnings growth in a difficult environment.

Today, this dynamic could be changing with reflationary pressures possibly emerging.

As disinflationary pressures took hold, risks were skewed firmly to the downside in areas such as sovereign rates and commodities. This, in turn, had a significant impact on the risk-reward calculation in various asset markets.

Following through with that logic, if the disinflationary dynamic is potentially changing today, there should be a shift in the probability of outcomes moving forward and the risk-reward profile in different asset markets.

But what has changed?

Central Bank Policy

For one, central bank policy. Following the longest pause after a hiking cycle in its history, the Federal Reserve cut interest rates by 50 basis points in September – and is likely to continue cutting from here.

Forecasted Fed Funds Rate

Analysis: Manning & Napier. Source: Bloomberg (9/30/2024).

While the magnitude of cuts is open for debate, the direction of travel for now seems clear. Thus, with the economy still resilient and inflation still above target, the Fed has joined the chorus of global central banks that have flipped from restrictive policy to more accommodative policy.

China’s Influence

The second largest economy in the world recently announced a significant shift in policy. China has been exporting disinflationary – to outright deflationary – pressures to the rest of the world due to its domestic economic situation. This is now changing.

Policymakers communicated a series of measures aimed at supporting property prices and driving consumption and also supporting the country’s equity market. The initial list of measures is a start, however, more than what’s been announced will be needed to fully enable a turnaround in economic growth, therefore markets are now expecting further support. This certainly presents downside risks should stronger support fail to materialize, but so too does it present upside risks if policymakers follow through.

Geopolitics

Geopolitics are another factor to be considered when we think about reflationary pressures in the world. Looking back to early 2022 when Russia invaded Ukraine, we saw a spike in commodity prices. This makes sense, as armed conflict tends to put upward pressure on commodity prices for a variety of reasons. Looking at the Middle East today, the ongoing conflict between Israel and Iran has the potential to meaningfully disrupt oil markets and the ability to transit the strait of Hormuz and the Persian Gulf. Does this mean that we should expect a spike in oil prices? No. The outcome is ultimately unknowable, but it does present upside risks that have to be considered.

What to Expect

When taking everything in aggregate, the balance of risks between disinflation and reflation has shifted. This has been reflected in markets such as Treasuries and commodities, where we’ve seen yields drift higher—particularly on the long end—and have seen signs of life in commodity prices.

Of course, a more reflationary world is just one potential outcome, and there is no question that downside risks to growth and inflation certainly still exist. In such an environment, we continue to remain focused on managing risk while also deploying our time-tested investment strategies to uncover new opportunities. In what we believe may well be a more volatile market environment, with more balanced risks regarding potential paths forward, investors are well suited to an active investing approach.

Enjoying this information? Sign up to have new insights delivered directly to your inbox.

This material contains the opinions of Manning & Napier Advisors, LLC, which are subject to change based on evolving market and economic conditions. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy, or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.