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Experts debate inflation and growth risks for markets

Nicki Bourlioufas  |  01 Nov 2021Text size  Decrease  Increase  |  
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As the debate over whether inflation is ‘transitory’ or not stay rages on, a new concern is moving onto investor radars: ‘stagflation’, or an environment of high inflation and low growth. We asked several fund managers about this new risk, whether inflation will persist, how it intersects with the outlook for global growth and the likely impact on equity markets.

The US Federal Reserve warned this month of rising prices and the risk of persistent inflation due to supply constraints. As lockdowns have lifted, demand for goods globally has jumped and supply chains are struggling to bounce back after COVID-19 related disruptions.

With bottlenecks persisting, Stephen Miller, investment strategist at GSFM, says we could be beyond the point of ‘transitory’ inflation.

“Inflation globally has been more persistent than most central bankers anticipated … As we enter 2022, there is some questioning of the notion that inflation will abate soon. For one thing, supply disruptions are ongoing,” says Miller.

Inflation is rearing even as higher wages and protectionist policies are pushing up costs and inhibiting the global economy’s flexibility, says Miller, “thereby running the risks that inflation stays elevated while a lack of economic flexibility inhibits growth – a potential ‘stagflationary’ environment.”

And the longer central banks take to respond to rising prices, the harsher the subsequent hike in interest rates may need to be and the bigger the shock to the economy, says Miller.

“If central banks then jam down hard on the monetary brakes, that may lead to sharp upward movements in bond yields and a significant correction in equity markets,” he says.

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However, while stagflation is a risk, he says it’s unlikely to be of a scale that was experienced in the 1970s.

Anthony Doyle, cross-asset investment specialist at Fidelity International, agrees that inflation is likely to persist even as risks to global growth are emerging.

“Ongoing supply chain disruptions, wage pressures and factors driven by the net-zero transition are likely to be key drivers of persistent inflation going forward,” says Doyle.

“The current power crisis in Europe will not only add to inflationary pressures but will also likely lead to a downturn in the European industrial sector this winter. At the same time, China’s macro and policy outlook and the potential spillovers to the rest of the world present a large risk for the global economy and markets.

“With all the headwinds on the horizon, we might be moving into a period of short-term stagflationary discontent.”

As a result, Doyle says Fidelity maintains a neutral equity position in its portfolios.

American Century Investments’ portfolio manager, Miguel Castillo, agrees about the risk of persistent inflation but thinks the impact on equities will be slight.

“Equities in general are good investment alternatives to protect against inflation as long as consumer sentiment remains healthy, and companies are able to pass price increases to consumers. Active management in a portfolio to select companies able to do that is critical,” he says.

In his review of the common inflation hedges, Morningstar’s Russel Kinnel argues that in an inflationary environment, equities tend to do all right over the long term.

Others worry about low inflation and low growth

In contrast, Reserve Bank Deputy Governor Guy Debelle doesn’t see inflation as a problem yet. Speaking before a Senate Committee last Thursday, Debelle acknowledged higher fuel prices but argued Australia’s inflation dynamics differed from what’s occurring overseas.

“The circumstances we are seeing here today in Australia are quite different from those we are seeing in places like the US,” Debelle said. 

“We are also not really seeing so much impact yet of supply chain disruptions in terms of influencing prices; businesses by and large have absorbed [higher costs] in their margins to date.”

The day before his comments, new data showed that Australian inflation rose sharply in the September quarter. The broad CPI rose 3% on a year-on-year basis and the RBA’s preferred underlying measure edged into the bank’s 2%-3% target range for the first time since 2015.

Financial markets are now pricing in higher inflation in Australia. The yield on Australian 10-year government bonds, which are sensitive to inflationary expectations, has jumped much more in Australia than in the US; it was up 41 basis points to 1.89% over the month to 1 November. In the US, 10-year Treasury yields rose 10 basis points to 1.56% over the same period.

Chris Siniakov, managing director of fixed income at Franklin Templeton Investments, echoes the RBA and doesn't expect stagflation or persistent inflation.

“It is important to recognise that a scenario in which inflation persists because of bottlenecks and supply constraints is a low growth scenario; positive but low growth,” he says. “We expect the inflation rate will settle lower in 2022.”

Likewise, Michael Spinks, portfolio manager with Ninety One’s (formerly Investec Asset Management), believes that inflation is transitory and price pressures will lessen in 2022. He argues the bigger risk for equity markets is slowing growth.

“If we were to fall into a global recession then we would expect growth assets, such as equities and high yield bonds, to fall sharply in value,” says Spinks.

“While consumers and corporates particularly in the US are in good shape, in the short term there are increasing risks to the downside which markets appear to be ignoring.

“The withdrawal of policy stimulus is increasingly likely to occur at a time when growth is also moderating. Additionally, the degree of tightening that has been seen in China has yet to feed through fully into macro data and historically has ultimately led to a slowing growth in cyclical economies such as Europe albeit with a lag. These dynamics are likely to surprise consensus to the downside,” says Spinks.

is a Morningstar contributor.

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