Cover story – Inflation
Back in control? However, Guppy says the Fed appears to be back on top of things. “They have made a pretty sharp pivot to acknowledging that they are behind the curve and that rates need to move up quickly and above what they perceive as the long-run neutral rate in order to get inflation under control. So, they seem to be back in control of the narrative again.” Yet David Lloyd, deputy chief investment officer of public fixed income at M&G, presents another scenario – one shared by some economic commentators – which believes central banks cannot always control the mechanisms of the financial system. “There’s a fairly clear recognition that many aspects of the inflation we are seeing are just not something the central banks can control,” he says. “The Bank of England mandate, openly accepts that inflation may drift away from its target, and in times of crisis, may indeed do so quite significantly and for a protracted period of time.”
The jury is out
If central banks can lose sight of the ball, it begs the question: where will this inflationary situation lead? And where will it end? The war in Ukraine makes an already bad situation incredibly worse. It raises the prospect of stagflation, that unwanted com- bination of slow economic growth mixed with higher inflation: a nightmare for investors.
“Stagflation is one potential scenario,” Doyle says. “Although, corporate and consumer balance sheets remain healthy, the jury is out about the extent to which rising interest rates will
curb demand and central banks will need to manoeuvre carefully.”
On the stagflation situation, Evan Guppy of the PPF warns investors to keep their eye on the UK. “If there is one country in the developed world most at risk of a stagflation-type scenario it is probably the UK,” he says. “Headline inflation is going to hit levels higher than the US and eurozone, whilst the outlook for the consumer is also bleaker in light of the lim- ited cushion provided to households against rises in energy prices, exacerbated by the rise in National Insurance contributions.” Yet Craig Mitchell, an analyst at workplace pension provider Nest, believes Europe also has big problems ahead. “The risks of the worst outcome – stagflation – are greatest in Europe, as it’s the most exposed to the fallouts of Russia’s invasion of Ukraine – Europe gets around 40% of its gas and 30% of its oil from Russia, with few easy alternatives.
“The impact on domestic energy will affect consumers and businesses through higher energy prices, as well as potentially limiting the available supply,” he adds. “On top of this, there are more direct trade impacts for Europe and financial condi- tions have been hit harder. Outside of Europe, we believe the risks of stagflation are lower.”
There’s a fairly clear recognition that many aspects of the inflation we are seeing are just not something the central banks can control.
David Lloyd, M&G
The end of moderation This could also be evidence of a shift in the macro-economic outlook. “You could term it as the wrong kind of inflation,” Lloyd says. “In this sense, many aspects of this inflationary problem are supply side, the current increase in inflation is something that bears no resemblance to anything we have seen for decades. Unfortunately, the ‘great moderation’, which included, amongst other things, moderation in inflation, has sadly come to an end.” This presents a genuine shift in the economic picture which investors cannot ignore and firmly puts to bed a transitory analysis. It also poses a dilemma for the Bank of England. How should it react? If it tackles inflation, growth could suffer fur- ther, if growth is given a boost, inflation could rocket. “Central banks are in a bind: do they support growth or do they try and tame inflation?” Lloyd asks. “On balance, they are still very much in the camp of supporting growth.” A point shared by Doyle. “[Central banks] need to ensure that the economy is able to bear higher rates, given elevated debt burdens, making it a delicate balancing act,” she says. This could lead to many taking a Private Frazer perspective from the sitcom Dad’s Army: “We’re doomed”. But investors are taking more of a Private Wilson approach to the situation: keeping calm and carrying on, taking the situation in their stride. “We have significant inflation hedges built into our portfolio,” Doyle says.
18 | portfolio institutional | May 2022 | issue 113
Page 1 |
Page 2 |
Page 3 |
Page 4 |
Page 5 |
Page 6 |
Page 7 |
Page 8 |
Page 9 |
Page 10 |
Page 11 |
Page 12 |
Page 13 |
Page 14 |
Page 15 |
Page 16 |
Page 17 |
Page 18 |
Page 19 |
Page 20 |
Page 21 |
Page 22 |
Page 23 |
Page 24 |
Page 25 |
Page 26 |
Page 27 |
Page 28 |
Page 29 |
Page 30 |
Page 31 |
Page 32 |
Page 33 |
Page 34 |
Page 35 |
Page 36 |
Page 37 |
Page 38 |
Page 39 |
Page 40 |
Page 41 |
Page 42 |
Page 43 |
Page 44 |
Page 45 |
Page 46 |
Page 47 |
Page 48 |
Page 49 |
Page 50 |
Page 51 |
Page 52 |
Page 53 |
Page 54 |
Page 55 |
Page 56 |
Page 57 |
Page 58 |
Page 59 |
Page 60
