Immaculate Disinflation: It’s a Miracle…or is it?

The financial media is abuzz (again) with that newly coined term: immaculate disinflation. The word, created by economists, is said to mark a decrease in the rate of inflation without a jump in unemployment. (BTW: There is no official definition of the word—yet,­­ since it may not even be a real thing, but all agree: it’s a miracle.)

Historically, achieving a significant reduction in inflation was cheered by everyone. But, this time, as we hover in a possible immaculate disinflationary environment — where we stand today, is, well, completely unclear. Immaculate disinflation is known to carry the well-documented sacrifice ratio which suggests that lowering inflation often leads to increased unemployment and as such, hinders economic growth.

In the US, inflation cooled from a peak of 9.1% in June 2022 to 0.6% in August, according to the latest Consumer Price Index. (The September CPI data is scheduled to be released next week.) Yet the unemployment rate actually fell from 3.6% in June 2022 to 3.5% in July 2023. The current rate is 3.8%, a mere 0.03 percentage point rise. All this has left economists and bankers scratching their heads, wondering if we are actually experiencing the mysterious immaculate disinflation.

We are not economists, investment strategists or asset class managers, and therefore, not qualified to argue if disinflation can be considered immaculate or not. But we can see the writing on the wall, unless a sudden shock hits the markets. If we are nearing a disinflationary environment as some economists posit, companies will need to be strategic about how they approach financing. While there are many factors that influence the capital markets, such as regulatory changes and monetary policy, historical trends indicate that both debt and equity issuance tend to increase following a period of disinflation. That’s great news for high-quality, profitable companies in pre-IPO mode, as the IPO market seems to be coming back after a lull.

While disinflation may be good news for profitable companies, it presents challenges and opportunities for others depending on their industry and financial strategy. One of the most immediate effects of disinflation is its influence on borrowing costs. In such an environment, central banks often adopt policies to stimulate economic growth and lending, such as lowering interest rates. For companies, this typically translates into lower costs of debt financing, making it cheaper to raise capital through bonds or loans. This can be especially advantageous for businesses looking to refinance existing debt on their balance sheets.

On the flip side, disinflation can exert downward pressure on a company's revenue and profitability. When prices rise more slowly, businesses may find it challenging to pass on cost increases to customers, potentially squeezing profit margins and credit. This scenario can be particularly relevant in industries where competition is intense. Some companies may have to rethink their pricing strategy to maintain market share and preserve profitability. This could involve cost-cutting measures such as lay-offs to remain competitive.

Disinflation can also influence how companies allocate their financial resources. In a low-inflation environment, the expected ROI may be lower. As a result, companies tend to be more selective in choosing projects and investments that provide a higher potential for returns.

While disinflation can reduce borrowing costs and enhance financial flexibility, it can also dampen revenue growth and necessitate strategic adjustments. The impact on company financings is far from one-size-fits-all. What remains to be seen, is how we’ll navigate the situation once it’s defined.

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HA