More pain to come for investors?
This week, FundCalibre held its annual investment dinner for financial journalists. Speaking at the...
Expectations of an explosive reopening of world economies in the coming months is causing inflation to become the investment topic du jour.
It hasn’t really been an issue for one or two generations in the UK, having peaked in 1979. And the last time it was above 5% was in 1995. Even after the global financial crisis, when central banks started their loose monetary policy, inflation stayed low – because it was followed by fiscal austerity. But what can we expect today when we have both monetary and fiscal stimulus?
As Rathbones’ Julian Chillingworth points out, in the US, the reopening boost is set to be supercharged by a stimulus bonanza. The Democratic-controlled House of Representatives is about to approve a $1.9 trillion spending package that includes another round of ‘stimmy’ cheques – $1,400 for every American earning $75,000 or less (including children). “It’s impossible to convey how gargantuan that amount of public spending is, especially when it has been unleashed in such a short time’” he said. “Red hot spending tends to stoke inflation, which is why government bond yields have started to shuffle higher in anticipation.”
So will that inflation be short-lived? Or will it gain momentum? Six investors give their views:
Richard Woolnough, M&G Optimal Income
“I think the inflation impetus is stronger than during the financial crisis. Why? Well for one, the monetary response is bigger. It’s huge. And last time we were going for austerity – trying to sort the problem out. This time round we’re ‘spend, spend, spend’, typified by the change in the administration in the US.
“I also think that the central banks want to get away from the zero interest rates so they can actually cut rates going forward. The only way that you’d get away from zero interest rates is to create inflation. So I think they’ve got a bias to create inflation and they’re becoming a lot more tolerant and relaxed about it than they were before. So I believe it’s a far more inflationary environment out there than other people may think. Whether it’s a blip for a year or two, or whether it’s a permanent change, we’ll wait and see.”
Hear more of Richard’s views in this podcast:
David Coombs, Rathbone Strategic Growth Portfolio
“One thing we aren’t optimistic about is the potential for a sustained rise in inflation. With most of the world still battling the virus, GDP won’t return to pre-pandemic levels until 2022/23. When inflation does return, we believe it will spike because of the “base effect” – a statistical quirk of recovery from extremely low levels – and then remain much as it has for years and years: muted.
“There’s just too much debt and too many unemployed workers for this to be any different, in our view. There are also massive changes in the global economy that make it harder for inflation to drive higher. If you think about the most profitable – the most successful – companies of today, they increasingly have little need of capital investment and physical materials. Compared with the past, at least. Most of the profitable growth is in intellectual property, ideas and software, not in tonnes of copper or hoppers of cement. We think that many of these companies are intrinsically deflationary, because they operate to offer more value for less money and to drive efficiency gains for households and businesses. As an example, think of how much you can do with the mobile in your pocket compared with 10 years ago. We doubt mobile prices have kept pace.”
Romain Duverge, Goldman Sachs
“Despite the economic recovery in 2021, we expect inflation in major developed market economies to trend higher but to stay in check with some near-term transient turbulence in the US. We expect inflation to remain below the corresponding central bank targets in the Eurozone, UK, and, more significantly, Japan. In the US, while we expect US inflation to rise meaningfully, Federal Reserve Chair Powell has stated that he would view such a rebound as “a transient increase in the price level” that the Committee is likely to look past when setting policy.
“Beyond 2021, our base case is for inflation to remain weak due to labour market slack and pre-existing trends, but we acknowledge that opposite forces result in a high degree of uncertainty.”
Mike Riddell, Allianz Strategic Bond
“I think bond investors are at risk of a disastrous misstep if they mistake a short-term spike in inflation for a long-term shift. The US Consumer Price Index will hit 3% by May – its highest jump since December 2011 – due to the base effect of 2020’s global lockdown low. But people are forgetting the base effects of these year-on-year changes. We think the market, the economists and investors will just look at the latest figures and freak out. That is a big worry. I believe any jump in inflation is likely to be temporary as even last year’s sinking commodity prices, with oil reaching negative territory in April, recovered in the second half of 2020.”
Julian Chillingworth, chief investment officer, Rathbones
“We think inflation could make uncomfortable reading in the spring and perhaps into the summer. Partly, this would be down to the ‘base’ effect: prices were pushed very low because of the COVID slump, so when they recover, annual increases in inflation will look sharp and worrying. We believe this spurt of inflation will be short lived though. There’s plenty of spare capacity in our economies, which should be able to help supply the greater demands of the newly freed people. Meanwhile, a large chunk of unemployed people will also take time to find work, which should reduce inflationary pressures as their ability to spend is curtailed.
“Our assumption would be tested, however, if households and businesses save less money than before because they assume that governments will simply bail them out in tough times. Another, unexpected stimulus package from the US could also upend the supply/demand dynamics in favour of higher inflation, as could more businesses failing than expected. In that scenario, there won’t be enough capacity to produce the goods and services that people are clamouring for – classic inflation.
So the consensus seems to be that inflation will not get out of control – especially in the short term. But, as James Mahon, manager of SVS Church House Tenax Absolute Return Strategies, pointed out in this video interview: “More than anything, it’s probably the perception of inflation rather than actual inflation that will upset the market. We are going to see some funny numbers coming out because comparisons to last year will be jumpy. And inflation expectations will go up even though I don’t think inflation will go up.”