Please use the menu below to navigate to any article section:<\/p>\n<\/div>\n
How are major central banks going to react to this year\u2019s inflation?<\/strong><\/p>\n What is a solution to the long-term downtrend in inflation and interest rates?<\/p>\n These and other questions were raised and answered by Dr. Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP in his recent Insight<\/a>.<\/p>\n Here\u2019s what he had to say\u2026<\/em><\/p>\n For the last few decades, inflation has not been much of an issue.<\/p>\n It was all about economic activity.<\/p>\n Books were even written about \u201cthe death of inflation\u201d.<\/p>\n In fact, for much of the post-GFC period inflation in many countries was below central bank targets and all the talk was of \u201csecular stagnation\u201d and disinflation with a fear of deflation.<\/p>\n Since around May last year though following a surge in inflation in many emerging countries and notably the US it\u2019s become more of an issue.<\/p>\n In fact, US inflation rose to 7% in December, a near 40 year high.<\/p>\n Even inflation excluding food and energy in the US has risen to 5.5%, a 30 year high.<\/p>\n This is pressuring central banks to remove monetary stimulus.<\/p>\n Is it likely to settle down this year?<\/p>\n What\u2019s the longer-term inflation outlook?<\/p>\n What will it mean for interest rates?<\/p>\n What will it mean for investment markets? And what are the best hedges against inflation?<\/p>\n But before we look at these issues it\u2019s worth considering why it\u2019s important for investors.<\/p>\n Until only a year ago all the talk was about the need to get inflation back up.<\/p>\n So what\u2019s all the fuss?<\/p>\n Inflation refers to a generalised and persistent rise in the price of goods and services.<\/p>\n When it\u2019s too low \u2013 say around 1% or less \u2013 it runs the risk of slipping into deflation which has often been associated with depression and makes it harder for central banks to achieve interest rates low enough to stimulate economic growth.<\/p>\n But when inflation is too high it tends to be associated with lower productivity, as much economic activity is directed towards protecting against inflation, shorter economic cycles, and more uncertainty \u2013 as was seen in the high inflation 1970s.<\/p>\n So central banks in developed countries have aimed for the happy medium of around 2% inflation per annum.<\/p>\n For investment markets, high inflation tends to be bad as it means:<\/p>\n All of this means that shares tend to trade on lower prices to earnings multiples when inflation is high, and growth assets generally tend to trade on higher income yields.<\/p>\n This was seen in the high inflation 1970s when shares struggled.<\/p>\n Of course, shares also don\u2019t like recession and depression associated with deflation so the best inflation level for the share market is around 2% inflation as it tends to be associated with the highest PE on US shares.<\/p>\n So the bottom line is that a sustained period of high inflation can be a problem for shares and other growth assets.<\/p>\n The key drivers of the rebound in inflation are a combination of:<\/p>\n Initially, it was narrowly based on a few categories subject to reopening, but it has broadened out with the median level of US CPI components\u2019 inflation rates rising sharply and 75% of US CPI components seeing inflation above 3%yoy.<\/p>\n In a big picture sense, the surge in inflation in the US is consistent with a large increase in its money supply, which has fed through to demand via significant fiscal easing.<\/p>\n While inflation is generally weaker in other developed countries \u2013 partly due to less monetary and fiscal stimulus \u2013 it has increased.<\/p>\n In Europe and the UK it\u2019s around 5%yoy.<\/p>\n In Australia it\u2019s around 3%yoy, although that\u2019s down from 3.8%yoy.<\/p>\n By contrast in China it\u2019s just 1.5%yoy and in Japan it\u2019s 0.6%yoy.<\/p>\n This has been partly due to ongoing disruption from coronavirus waves which have kept goods demand up and constrained supply.<\/p>\n However, some fall back in inflationary pressures is likely this year as goods demand retreats from levels well above trend, in favour of services, and as production improves.<\/p>\n There are some tentative signs of this, with input and output prices rolling over in global business conditions (PMI) surveys, the Baltic Dry shipping cost index down from its highs, and producer price indexes showing some loss of momentum.<\/p>\n The pandemic has likely changed many things, which combined with various other forces are likely to mean an end to the period of post-GFC \u201csecular stagnation\u201d.<\/p>\n A bit like World War Two finally put an end to the deflationary forces of the 1930s.<\/p>\n In a longer-term context, we are likely seeing the bottoming of the long-term decline in inflation since the early 1980s:<\/p>\n Massive money printing was combined with massive fiscal stimulus (particularly in the US) which provided a means for easy money to boost spending (unlike last decade when fiscal austerity offset easy money).<\/p>\n A shift from focussing on the forecast to actual inflation also meant central banks will be slower to raise rates allowing inflation to rise further which is what we saw last year in the US.<\/p>\n This constituted a \u201cregime shift\u201d in the approach to boosting inflation \u2013 much like the aggressive approach to keeping inflation down led by the Fed from the early 1980s was a \u201cregime shift\u201d.<\/p>\n The bottom line is that many of the factors that drove the declining trend in inflation since the early 1980s are now fading.<\/p>\n In this context, the current spike in inflation is likely part of a longer-term bottoming process.<\/p>\n However, it\u2019s not all one way (technological innovation is still bearing down on prices, and the pandemic may work to drive more productivity) and the 1960s showed us the bottoming of inflation may take years to play out.<\/p>\n But it all likely suggests that the long-term decline in inflation since the early 1980s and the downtrend in interest rates and bond yields that it largely drove are over.<\/p>\n This will likely remove a tailwind from share and other growth asset returns.<\/p>\n Central banks started to remove monetary stimulus last year.<\/p>\n After seeing the spike in inflation for much of last year as \u201ctransitory\u201d the Fed has now ditched the term and is moving to remove monetary stimulus faster.<\/p>\n It may end its quantitative easing bond-buying program this month and we expect it to start raising rates in March, with four or five rate hikes this year, and start quantitative tightening in the second half.<\/p>\n The RBA is lagging behind the Fed and for good reason, as inflationary pressures are less in Australia.<\/p>\n Inflation here is less than half what it is in the US, only about a third of CPI items are seeing inflation above 3%yoy compared to 75% in the US, and wages growth is only 2% here compared to around 4.5% in the US.<\/p>\n However, despite another temporary coronavirus setback with Omicron, growth is likely to be strong this year pushing unemployment down to 4% and the pace of wages growth up to 3% later this year and so we see the RBA starting to raise the cash rate in November and taking it to 0.5% by year-end.<\/p>\n And it\u2019s likely to end quantitative easing in either February or May.<\/p>\n By contrast, the ECB is unlikely to start raising rates till next year.<\/p>\n Rate hikes in Japan with zero inflation are likely years away.<\/p>\n And China\u2019s central bank has started to ease monetary policy and will likely ease further to boost growth.<\/p>\n The higher levels of inflation and more major central banks removing monetary stimulus will result in a constrained and volatile ride for investment markets this year:<\/p>\n Of course, if inflation gets out of control and looks like staying well above central bank inflation targets the valuation boost from low inflation and low interest rates will start to be reversed, resulting in poor returns from growth assets.<\/p>\n This is not our base case, but it\u2019s a risk.<\/p>\n For those worried about a return to much higher inflation driving much higher bond yields and weighing on sectors like high PE tech stocks, the best protection remains inflation-linked bonds, real assets (like commodities), and parts of the share market that will see stronger earnings growth.<\/p>\n Guest Author: Dr. Shane Oliver is Head of Investment Strategy and Chief Economist at AMP Capital. You can read the original article here<\/a>.<\/em><\/p>\n<\/div>\n![\"Shane](\"https:\/\/cdn.propertyupdate.com.au\/wp-content\/uploads\/2021\/09\/shane_oliver_300-300x300.jpg\")
<\/strong>How will inflation and rising interest rates affect investment returns?<\/p>\n![\"Chart01\"](\"https:\/\/cdn.propertyupdate.com.au\/wp-content\/uploads\/2022\/01\/chart01-1.jpg\")
<\/p>\n![\"Oliver](\"https:\/\/cdn.propertyupdate.com.au\/wp-content\/uploads\/2019\/03\/oliver-money-question-300x220.jpg\")
But what\u2019s driving higher inflation?<\/p>\nWhy does inflation matter for investors?<\/span><\/h2>\n
\n
![\"Oliver](\"https:\/\/cdn.propertyupdate.com.au\/wp-content\/uploads\/2018\/09\/oliver-bank-300x220.jpg\")
higher interest rates;<\/li>\n![\"Chart02\"](\"https:\/\/cdn.propertyupdate.com.au\/wp-content\/uploads\/2022\/01\/chart02-1.jpg\")
<\/p>\nWhat\u2019s driving the rise in inflation?<\/span><\/h2>\n
\n
![\"Oliver](\"https:\/\/cdn.propertyupdate.com.au\/wp-content\/uploads\/2018\/12\/oliver-inflation-300x220.jpg\")
base effects \u2013 as 2020\u2019s deflation dropped out of annual calculations, although we have now gone well beyond that;<\/li>\n![\"Oliver](\"https:\/\/cdn.propertyupdate.com.au\/wp-content\/uploads\/2020\/02\/oliver-coronavirus-300x220.jpg\")
The further supply-side disruptions associated with the Omicron wave are not helping.<\/p>\nWill inflation settle down this year?<\/span><\/h2>\n
![\"Oliver](\"https:\/\/cdn.propertyupdate.com.au\/wp-content\/uploads\/2018\/07\/oliver-growth-300x220.jpg\")
The spike in inflation has gone on for longer than first expected forcing the Fed to ditch the use of the word \u201ctransitory\u201d when describing it.<\/p>\n![\"Chart03\"](\"https:\/\/cdn.propertyupdate.com.au\/wp-content\/uploads\/2022\/01\/chart03.jpg\")
<\/p>\nBut is higher inflation likely to become the new norm?<\/span><\/h2>\n
\n
![\"Oliver](\"https:\/\/cdn.propertyupdate.com.au\/wp-content\/uploads\/2020\/04\/oliver-bank-money-300x220.jpg\")
2020 saw central banks start to take a far more aggressive approach to pushing-up inflation.<\/li>\n<\/ul>\n\n
![\"Oliver](\"https:\/\/cdn.propertyupdate.com.au\/wp-content\/uploads\/2019\/03\/oliver-economy-300x220.jpg\")
The pandemic appears to have accelerated this problem by boosting retirement in some countries like the US (although it\u2019s less evident in Australia) and it refocused workers on quality-of-life considerations making them more demanding in terms of pay.<\/p>\nHow will central banks react?<\/span><\/h2>\n
![\"Oliver](\"https:\/\/cdn.propertyupdate.com.au\/wp-content\/uploads\/2019\/05\/oliver-bank-300x220.jpg\")
Several have already raised rates \u2013 in the UK, Norway, Korea & NZ.<\/p>\n![\"Oliver](\"https:\/\/cdn.propertyupdate.com.au\/wp-content\/uploads\/2020\/02\/oliver-pandemic-300x220.jpg\")
<\/p>\nImplications for investment markets<\/span><\/h2>\n
\n
![\"Oliver](\"https:\/\/cdn.propertyupdate.com.au\/wp-content\/uploads\/2018\/09\/oliver-cycle-300x220.jpg\")
Bond yields are likely to drift higher as it becomes clear that inflation will remain higher for longer. This likely means another year of capital losses on bonds.<\/li>\nWhat are good hedges against higher inflation?<\/span><\/h2>\n