Inflation falls again

The money printer will soon fire up, brrr

Inflation falls again, but the real story is just beginning

U.S. inflation fell more than expected in April, surprising many economists and market watchers. According to the latest data, year-over-year consumer price inflation dropped to 2.3%, down from 2.4% in March. While this may appear to be a small shift, it marks a continuation of a broader trend: disinflation is taking hold, and with it, the potential for significant changes in monetary policy.

A glance at the CPI chart shows that despite recent volatility, inflation has generally been declining. This was unexpected by some, particularly in light of ongoing tariffs. But contrary to popular belief, tariffs do not necessarily raise prices across the board. When specific goods become more expensive due to taxation, consumers tend to reduce spending elsewhere. The net result is often slower economic activity, not generalised inflation. Without a broad increase in the money supply, a sharp rise in prices becomes unlikely.

Why lower inflation may lead to more liquidity

The Federal Reserve has three legal mandates: to maintain employment, price stability, and moderate long-term interest rates. Yet it has only one primary tool to manage all three: the money supply. Liquidity can be added or withdrawn, which affects each mandate differently.

Injecting liquidity (printing money) helps reduce unemployment but puts upward pressure on prices. Withdrawing liquidity helps lower inflation but risks higher unemployment. With inflation falling, there is now greater room to add liquidity without stoking excessive price growth. In the context of a softening labour market, with initial jobless claims ticking up, the case for lowering interest rates and perhaps even ending quantitative tightening becomes stronger.

Understanding the long-term mandate on interest rates

There is a lesser-known component of the Federal Reserve's responsibilities: moderating long-term interest rates. This can include 10-year, 20-year, or even 30-year bonds. Although the specific targets are open to interpretation, the central idea remains the same. Policymakers are expected to ensure that long-term borrowing costs do not become disruptive.

The challenge is that interest rates are not solely a function of central bank policy. They are also deeply influenced by the broader debt cycle.

A historical perspective: deleveraging then and now

Between 1940 and 1980, the United States went through a long deleveraging process. Government debt as a percentage of GDP fell from around 120% to 30%, even as interest rates and inflation rose. During this period, the Federal Reserve used tools such as yield curve control to assist in reducing the relative debt burden. This period is best understood as an inflationary deleveraging.

From 1980 to 2020, the trend reversed. Interest rates steadily declined, enabling a massive increase in public and private sector debt. The US debt-to-GDP ratio returned to 120%. Now, the pendulum has swung back again.

The current era is one of renewed deleveraging. Inflation is rising, interest rates have climbed, and the debt-to-GDP ratio is beginning to fall. This is again an inflationary deleveraging, and it has significant implications for markets, savers, and borrowers.

What to expect going forward

Although there will be periods where interest rates temporarily decline, the long-term trend is clear. Rates are generally heading higher, as the US government attempts to manage its debt burden by borrowing at rates below inflation.

This shift should prompt a reassessment of long-term financial strategies. When interest rates dip, it is an opportunity to lock in low-rate debt and acquire assets likely to benefit from future money printing. Hard assets, equities, and productive real estate stand to benefit most in such an environment.

This is not merely a cyclical shift. It signals the end of a four-decade-long period of falling inflation and falling interest rates. The bond bull market that began in the early 1980s is now over. What follows is likely to be a prolonged bond bear market, where rising rates erode the value of fixed income and central banks become the dominant buyers of government debt.

Navigating the next macro era

Asset prices are already reacting. A new bull market appears to be forming as investors begin to price in this altered reality. In a world of structurally higher inflation and government-facilitated debt reduction, asset prices may continue to rise—not because fundamentals have improved, but because currency is being devalued.

Understanding this shift is critical. It is no longer sufficient to assume that past patterns will repeat. A new macro environment is taking shape, and it demands new strategies.