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In a world where supply chains are disrupted and energy, products, and transportation capacity are clearly in short supply, inflation is high.In Germany, it has reached 4.5%, Spain is 5.5%, and the United States 5.4% And in Brazil more than 10%.
Investors must weigh how serious this is and whether it is indeed a temporary short-lived. The central bank tells us that with the end of the lockdown, price increases will be modest. They expect inflation to fall back quickly as the economy returns to normal. At the end of last year, the Fed believed it would rise to 1.8% this year. In March, they adjusted it to 2.4%.
Today’s price is more than twice its price. In December 2020, the European Central Bank believed that the EU’s inflation rate would only increase by 1% this year, but the current inflation rate in the Eurozone is four times this number.
Driven by the large-scale monetary and fiscal stimulus measures provided by the authorities, as the economy opens up, prices seem more likely to rise.
Because I didn’t believe the central bank’s predictions, I cut the longer-term bonds in my portfolio and replaced them with inflation-linked short-term Treasury bonds and more cash. I worry that inflation may be more active than central bank officials estimate, which may lead to a greater sell-off of ordinary bonds as interest rates rise.
It wasn’t until December of last year that the Fed predicted that it would not raise interest rates in 2021 or 2022. All the topics now are about when to reduce bond purchases and interest rates must rise to curb inflationary trends.
The central bank still believes that inflation will fall again, but their determination to maintain monetary easing and focus on promoting recovery is showing signs of faltering.
We see interest rates in South Korea, New Zealand, and Norway have risen by 0.25% at lower levels; in Brazil to 7.75%, in Hungary to 1.8%, in Mexico to 4.75%, and in Russia to 7.5%. So far, the Fed and the European Central Bank have been opposed to tightening policies, but because they have been forced to drastically revise their forecasts, they are changing their wording and reconsidering policies. They need to show that they are responding to reality.
They can still point out that most of the current high inflation comes from several areas. As economies start fossil fuel plants, shortages of oil and natural gas have led to rapid increases in energy prices. This usually leads to more supply and some corrections. After all, timber prices rose first and then fell. The chronic shortage of microprocessors has led to a lack of new car parts in the auto industry and helped push up the price of used cars.
Supply chain misalignment From China to California via Europe, unpredictable goods are temporarily in short supply. Some consumers want to buy more inventory, making the shortage worse. Central banks can stick to their theory that recovery is fragile and price pressures are temporary.
Instead, they appear to slide to a more cautious position, responding to the inflation in the rearview mirror by applying more brakes to prevent a worse situation ahead.
The Fed will consider reducing its purchases of government bonds and allow the market to make some guesses about the timing of future interest rate hikes. The European Central Bank is trying to block the request for action, but may have to provide more evidence on how much quantitative easing it continues to implement and how long it will last. Only the Bank of Japan may be able to continue its endless program of creating cash and purchasing financial assets because it is an advanced economy that cannot ignite the engine of inflation.
Some people believe that central banks should worry more about what they release. After the blockade caused serious disruption to employment, labor markets on both sides of the Atlantic were extremely hot. This does not mean that more unemployed and more people seek any form of work to replace lost jobs, but a shortage of chefs and paramedics, truck drivers and hotel staff. It seems that more people decide to retire early or switch to part-time work after experiencing home isolation.
Those engaged in occupations such as truck driving now expect better rewards and employment conditions. During periods of distortion, currency growth is very strong, and millions of people who stay in work have more savings because they cannot spend money on holidays, activities, and travel to work. Banks have sufficient cash and reserves, so they can lend more. If people decide to reduce savings in a hurry, or if banks promote credit more actively, the fire of inflation will really be ignited.
Central bankers need to pay attention to all this. It may be tax increases and some fiscal orthodoxy, coupled with consumer caution, means that the economy will slow down and prices will not soar further. This makes judgment more difficult. Over tightening of the currency, the weak economy will go backwards even before all the output losses caused by the health crisis are restored. By doing nothing, you can allow inflation expectations embedding and wages to reinforce the high prices of many scarce items.
The United States has injected more cash, and there are more inflation problems. The EU is keen on a faster green transition, which will cause a lot of capital destruction. This in turn may push up prices. I insist on taking an anti-inflation stance on bonds until the situation becomes clearer, and I expect yields to rise further to make bonds attractive again.
I also hope that the central bank can find Goldilocks’ “just right” answer to support the fund’s stock investment. Moderate inflation does little damage to stocks. Trying to stop inflation too quickly can cause harm and require protective measures for the investment portfolio.
Sir John Redwood is Charles Stanley’s chief global strategist. The FT fund is a virtual investment portfolio designed to demonstrate how investors can use a wide range of ETFs to access the global stock market while reducing investment costs. [email protected]
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