Inflation is rising. In the US, it now sits at 5.4% pa and just last week New Zealand confirmed a rate of 4.9% pa. These are the highest levels of inflation in over a decade. The main concern evolving in financial markets right now is whether the inflation genie is out of the bottle permanently.
Complicating the issue is that many investors have long been worried that governments around the world are creating serious inflationary pressure with quantitative easing, asset purchases and money printing over the past 10-15 years.
Over the course of the pandemic, the price of many goods and commodities have skyrocketed. The biggest question now facing financial markets is whether these increased prices, combined with supply shortages, will lead to a permanent jump in inflation. If inflation does increase significantly and leads to interest rate rises, it will be a problem for everyone.
If interest rates go up, and go higher, it is a real concern and with serious implications. It would result in a one-off re-rating of asset prices across the world. Almost all assets would fall in value as markets adjust. Bonds would fall, as would most stocks, especially high growth stocks. High inflation is a big deal.
In relation to the money printing impact, my view is that we are still years away from seeing the inflationary impact of this. The reason being is that the quantitative easing money wasn’t pushed into the consumption economy. Instead, been captured within assets for now and while its forced asset prices up around the world it is going to take many more years to flow through into the economy and create price inflation.
So, in my opinion, that’s a separate issue from the current inflation spike. It’s a problem, but not today, and it isn’t the source of the inflation we are dealing with now.
I think the current bout of inflation brewing is really just due to supply chain disruption caused by repeatedly closing and opening parts of the global economy as the world went into lock down. Combine that with the unusual buying patterns that followed from consumers and businesses in the past 18 months, and you’ll obviously have supply chain bottlenecks as a result, forcing prices higher.
However, everyone brought forward a lot of spending on goods while stuck at home. They don’t need more. But no one was spending on services. That’s going to change in 2022. I expect spending on goods and commodities to fall in 2022, while spending on services increases as the global economy reopens.
If so, we will see the current supply chain bottle necks and the congestion at ports around the world start to ease. This will all work itself out in my view. It will just take time. That’s good news for inflation. In fact, there are four main reasons I am not overly concerned with the inflation we are seeing now.
The first is as I mentioned, supply chains will rectify themselves and we will likely see less demand for goods than normal in the coming 12 months. Prices are more likely to come down as supply and demand normalise.
Second, as people realise that the demand for goods is falling, a major component is removed from the inflation equation, expectations of higher prices. This removes the need for people to rush to buy before prices go up which perpetuates inflationary pressures. If prices start coming down, they will wait.
Third, ongoing impact of technology is deflationary. Shortages in any area whether its labour or energy or commodities accelerates technology trends and creates permanent additional capacity.
Fourth, the slowdown in China is real and it’s going to impact global growth. It will especially impact the Australian economy, subject to the degree to which the property sector there slows.
Regardless of how it plays out, the spectre of inflation will make for a relatively difficult 12 months with the market coming to grips with the real story as it unfolds. In my view, inflation pressures will likely subside in due course. For Australia, I am far more concerned about the impact of the slowdown in China in 2022. I think that is the emerging headwind for the Australian economy next year.
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