Inflation – Cover story
Inflation is no longer lurking, like a phantom menace, but instead a genuine threat in plain sight. We are in unknown inflationary territory. It is reaching levels – currently 7% in the UK and 8.5% in the US – not seen for decades. And it could reach heights never expected with the Bank of England conced- ing that an increase to 8% is just around the corner. As a result, the word transitory is no longer applied to the infla- tionary picture. The Bank of England has removed all refer- ence to the ‘T’ word. Clear evidence, if it was needed, that the inflationary game has truly changed.
The standard and much-repeated interpretation of what is hap- pening points to a return to the wild inflationary days of the 1970s, when inflation reached a jaw dropping 26.9%. But Catherine Doyle, investment strategist in the real return team at Newton Investment Management, believes that this time it is different. “While it is tempting to draw comparisons with the past, the interest rate backdrop is very contrasting: interest rates were nearly 20% in the 1970s and it was the end of the Bretton Woods era, to name but a couple of differences,” she says. Financial historian Niall Ferguson presents a different narra- tive. “My sense is that we are not heading for the 1970s, but we could be re-running the late 1960s, when famously the Fed chair, William McChesney Martin, lost control of inflation expectations.”
This suggests a possible worse scenario than the normal paral- lels with the 1970s. With the current situation – being the 1960s – offering up just a taster for possibly more dangerous times ahead – when we see a real rerun of the 1970s.
Behind the curve If you take the basis of the Fed and other central banks having lost control, this is a possible and terrifying scenario. Every inflation outlook central banks have released during the last 12 months has had to be upgraded in some form because infla- tion had exceeded expectations. “The Fed is behind the curve,” Doyle says, “but to say that they have lost control is an exaggeration. They are compelled at this juncture to raise interest rates aggressively in view of elevated inflation figures.” Some point to the fact that the Fed should have followed the advice of the third president of the United States, Thomas Jef- ferson: “Don’t put off for tomorrow, what you could do today” – meaning the Fed was far too late in raising interest rates. On this point, Evan Guppy, head of liability-driven investment (LDI) at the Pension Protection Fund (PPF), says the Fed accepts its mistake. “The Fed themselves have acknowledged that they are probably starting to tighten policy too late and it is hard to disagree with that: they were still expanding their bal- ance sheet in March when headline inflation hit 7.9%.”
Issue 113 | May 2022 | portfolio institutional | 17
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