We reviewed 30+ research pieces published by asset managers in the past months, most of which were inflation-related. This observation probably does not sound surprising to those who read our mid-year outlook review of investment managers and the monthly investor sentiment survey we evaluated earlier this month.
In this article, we are giving you an update on investment managers' views on inflation, a list of potential long-term drivers of inflation, and a few ideas on strengthening your equity narrative against inflation risks. But first things first, let's get the definition straight.
What inflation are we talking about?
There are two main inflation measures, CPI and PCE. For our article, we will focus on CPI because it is the most common and the one that gets the most media attention. However, PCE is no less important as it is the official metric used by the Fed.
• CPI (or headline CPI): this is the broadest measure of inflation. It is based on the costs of a fixed basket of goods/services.
• Core CPI: this is simply the CPI excluding food and energy costs
• Sticky CPI: it is a subset of the CPI that includes components that change price less frequently, for example, shelter, medical care services, and transportation services. What's worth noting is that a study by Cleveland Fed in May 2010 showed that sticky CPI is a better leading indicator of inflation than other CPI measures.
• Flexible Price CPI: this is the opposite of sticky CPI and is calculated from a subset of goods and services that change price relatively frequently.
Too early to claim victory
Although most investment managers expected inflation to peak in 2H22, they are cautious about the early signs of weakening inflation. To recall, the July CPI showed 8.5% YoY, which was 0.2% below expectation and 0.7% below the June number. In a detailed note, PIMCO points out that neither sticky inflation nor the labor market confirm a potential change in the inflationary trend. It sees the Fed persisting with outsized hikes. Fisher Investments reminds readers that declining inflation is simply due to the base effect. Allspring is also nuanced on the CPI number; while it sees a lot of breadth and depth in the inflation rise, it also argues that the trend may be turning soon. Other investment managers, such as Capital Group, Amundi, Schroders, and LGIM focused on slow growth/recession risks in their Aug macro comment instead of interpreting July inflation. Overall, the view is that a change in the inflation trajectory may not be enough for the Fed to pivot in the short-term while the potential long-term upward drivers of inflation remain.
Where can long-term inflationary pressure and volatility come from?
• Re-globalization or the change in nature of globalization: geopolitical tensions are likely to accelerate the near-shoring/reshoring/friend-shoring phenomenon. While the international reorganization of the supply chain will help reduce its vulnerabilities, the investments involved and the loss of economies of scale will add to the cost of goods produced – see Capital Group.
• Energy transition and Greenflation: Schroders reiterated that pressures from government and investors and uncertain long-term demand outlook have severely dampened investments in new fossil fuel supply. In parallel, the support for investment in net-zero transition infrastructure has increased related materials prices sharply.
• Structural limitation of labor supply: the aging population in developed countries will put secular pressure on the labor supply if there is no loosening of immigration policies. The growth of the working-age population in G7 countries peaked in 2018 and has declined by about 1m yearly. Unfortunately, mounting populism will likely curb immigration and maintain the labor supply imbalance.
• Food production. In an interview in July by Goldman Sachs, Chris Barrett, a professor at Cornell University, explained that the global food production system would remain vulnerable to climate and geopolitical shocks, and price volatility will persist if efficient and low-cost food production does not rise.
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