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Inflation: beyond transitory

Inflation: beyond transitory

Summary

Inflation has made a forceful comeback recently, and we believe it will last longer than the financial markets and many investors currently anticipate. In part one of a two-part paper, we look at the factors that may cause a more persistent rise in consumer price inflation – and why it matters to investors.

Key takeaways:

  • The recent inflation spike has been amplified by several extraordinary and temporary factors – including the post-Covid rebound and base effects
  • But there are other reasons why consumer price inflation may turn out to be “sticky” – including continued accommodation from central banks, less globalisation and an aging population
  • We also expect the fight against climate change and economic inequality to contribute to upward inflationary pressure

The inflation spike is real – and it may last for some time

After years of subdued price pressure and a brief disinflationary bout early in the Covid-19 pandemic, global inflation has made a forceful comeback. Consumer prices in OECD countries rose by 4.3% from August 2020 to August 2021 – the fastest pace in 13 years.1

But contrary to the market consensus, we believe that only part of the inflation spike is transitory. To be sure, some of the recent rise in inflation is a byproduct of the sharp post-Covid economic recovery, powered by unprecedented monetary and fiscal stimulus, lingering pent-up demand and surging commodity prices. The inflation spike has also been amplified by several extraordinary and temporary factors – including base effects, tax effects and supply-side bottlenecks.

Yet in our view, there are cyclical and structural forces at work that could lead to a more persistent rise in goods and service inflation in the years ahead. Importantly, we believe this increase could be notably more than what the financial markets and many investors currently anticipate. We expect inflation to regularly reach and at least temporarily overshoot central banks’ targets over time. That makes it worthwhile to take a deeper look at the factors that are driving inflation higher.

Eight factors driving inflation higher

Learn more about the implications for investors

Taken together, these eight factors make a compelling argument as to why consumer price inflation may turn out to be more sticky than what the market currently anticipates. As a consequence, it may be a good idea to hedge against the risk of a persistent rise in inflation. In part two of this two-part paper, we share the results of our proprietary analysis into the asset classes that may provide an optimal inflation hedge.

Download the pdf version

1 Source: OECD as at August 2021. OECD is the Organisation for Economic Co-operation and Development.
2 When consumers, corporations and other parties expect inflation to remain steady, their “anchored” inflation expectations help central banks maintain price stability. If inflation expectations are de-anchored to the downside, the markets think inflation will be lower than the central banks’ target level.
3 In the US, the multi-year growth in broad money supply now exceeds the multi-year growth in real GDP by a wide margin. Historically, this measure of excess liquidity has also coincided with a rise in consumer-price inflation.
4 They do this by pegging interest rates at artificially low levels to reduce the costs of servicing sovereign and private debt.
5 This also has the added political aim of helping countries ensure the domestic supply of critical products, which increases their strategic self-sufficiency.
6 For a deeper discussion of the demographic impact on inflation see, for example, Goodhart, C., Pradhan, M. (2020): “The Great Demographic Reversal” and Juselius, M. and Takáts, E. (2018): “The enduring link between demography and inflation”
7 The precise mechanism linking high inequality and low inflation remains unclear, but one driver is that lower-income households tend to consume more. Higher consumer spending tends to push up inflation, all else equal.
8 Other factors pushing up gas prices include supply-side constraints and a generally higher demand for energy.

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Don’t downsize your goals

How investors can guard against lasting inflation

tiny car with money

Summary

How can investors reposition their portfolios in the face of a persistent rise in consumer price inflation? In part two of a two-part paper, we share the results of our proprietary analysis into the asset classes that may provide an optimal inflation hedge.

Key takeaways:

  • Given our view that inflation is set to last longer than many market watchers expect, we conducted our own analysis into how different asset classes performed in a range of inflation environments
  • Our research found that with moderate inflation (2%-4%), equities were the top-performing asset class, and sovereign and corporate bonds both generated decent positive annual real returns
  • Perhaps surprisingly to those who consider gold to be the ultimate hedge against inflation, gold’s returns were mixed across different inflationary environments
  • Commodities consistently generated solid positive returns in times of high and rising inflation, but their longer-term outlook may be obscured by the transition away from fossil fuels

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