Inflation has bounced back forcefully from its pandemic-era lows: the headline rate for the US consumer price index has reached a 40-year high, while in the eurozone, the headline rate for the harmonised index of consumer prices is at its highest in 20 years. What does this mean for investors?
Russia’s invasion of Ukraine has added a further supply shock, coming on top of supply chain bottlenecks and post-pandemic reopening effects. It will likely worsen inflationary pressures and reduce real disposable incomes and economic growth.
We believe that for the foreseeable future, sustained inflation modestly above central bank targets is likely. In the US, a stronger job market, rising shelter costs and tight commodity markets will keep inflation from falling back to the US Federal Reserve’s target. In the eurozone, higher inflation, rising minimum wages and a robust recovery may trigger faster wage growth.
Technological advances and digitalisation will likely help contain inflation, but other secular forces are becoming less disinflationary, or even inflationary. They include high debt loads; higher consumption/a shrinking workforce/lower savings; a drop-off in international competition; redistributive fiscal policies and sped-up spending on the energy transition.
As a result, it has become increasingly important for investors to manage inflation risks. Inflation-linked bonds can be an important building block. They can provide robust inflation protection over the long term and diversification benefits over equities in a downturn.
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