Banking

Conflation of inflation: The great carry-on trade?

That ‘Amazon effect’ was momentous and deflationary, as it ravaged physical presence shopping, demised high streets, supplanted payrolls and reduced workforces with cheaper bots. 

Side-effects of this were supposed to include a suppression in wage inflation as workforce’s shrank around technology platforms while technology became cheaper. This view has validated a decade long disinflationary super-cycle hangover from the global financial crisis 12 years ago.

The rationale was that technology and rampant money supply had expanded global indebtedness, triggering inflation in asset markets but not in the real economy. 

Governments, companies and consumers could not afford to repay that debt at normalised rates and therefore central banks would continue to pump in money to allow easy refinancing. Markets seemed happy with this notion so long as prices moved up. Markets did not want normalisation, they only wanted a “new normal”.

Then two things happened. First, the growing climate crisis led to rapid political steps towards a ‘transition economy’ which, by all accounts, will create huge capital effects, many of which will be inflationary. 

The second reason was a global pandemic, which suddenly turned the world on its Friedman economic head, as the helicopters flew in. Wages became state subsidised, industries bolstered, e-commerce accelerated and debt grew. 

As the pandemic ends we are seeing a capital model that leans more to the political left than before the crisis. This is feeding through into rising living wages, pay equality and improvements to worker rights in the gig economy.

These events leave us with higher costs and higher indebtedness. When these events spark inflation it increases the expectation of rising rates. Inflation diminishes the burden of paying that debt and means £1 debt tomorrow is a little less than £1 of debt today. Meanwhile if central banks could look to raise rates as means to maintain returns to investors, currency parity, cost of living and keep the national debt serviceable. 

However, I have seen no evidence that policy hawks exist without doves or visa versa. Between them they produce a cycle that is inevitable; inflation should rise and fall over time. Something we have lost sight of.

As we emerge from our lockdown-imposed depression, inflation is beginning to re-emerge in the real economy, and in volatile patterns. For instance workforces (deployed to facilitate a click and deliver consumerism) face real supply shortages for the first time and materials and food stuffs have suffered supply shortages and bottlenecks. If input costs rise across all sectors then the inflationary pressure looks real.

Fed signals tapering of bond buying in “tantalisingly vague” message

Meanwhile some markets have again rocketed and display bubble-like symptoms. This for me makes assets sensitive to inflation even less resilient. The rise of cryptocurrencies and social media investing are some of the more pronounced signs. This conflation of inflation should have investment committees nervous from:

  • Rising prices, input costs and future rates
  • Rising wages (in pockets)
  • Erosion of purchasing power of retirees, collapse of annuity rates on a real basis 
  • Impact of transition economy and net zero on energy, metals and materials
  • Weather effects on water intensive goods (semi-conductors) and foodstuffs
  • Increasing market bubbles observable inside and outside of mainstream finance
  • Rising private markets 
  • Interconnectedness of assets from inflation effects 

I would urge my fellow Investment Committee members to carefully look at the sentiment and data coming from inflation-focused asset managers. There are many good teams looking at inflation closely, for example the team at Man Group. 

“While we wouldn’t call that panic stations, it does indicate to us that there is enough pressure to the upside to make it worthwhile worth doing the risk management work now to ensure investors can respond quickly in the event we get more uniformly red signals,” they said in a report published in August.

However, not all teams are as experienced. Twelve years on from the global financial crisis and we have a generation of colleagues who have no working experience of normalised-higher inflation or rates. Meanwhile, markets have evolved since the last period of higher inflation. This brings complexity so it is important to beware of forecasts. 

JB Beckett is an iNED and author of #newfundorder

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