Home Analysis Is Inflation Cheap?

Is Inflation Cheap?

Stockholm (Ekonamik) – According to Scott Thiel, Chief Fixed Income Strategist at the BlackRock Investment Institute growth is expected to edge upwards in 2020. The view, presented at Grand Hotel in Stockholm, Sweden, on Tuesday, January 14th, is fundamentally driven by two underlying assumption about the economy in the coming 12 months.

On the one hand, financial markets appear to have recovered and stabilised in 2019 compared to losses they suffered at the end of 2018. According to Thiel, this stabilisation was facilitated by accommodating monetary policy. Following rate cuts across global central banks, BlackRock’s expectation is that no further action will take place during 2020.

The other driver of economic growth identified by the strategist is the easing of international trade tensions between the USA and its partners, particularly China. Consistent with what we had heard from Amundi the wee Affected industries, such as the automotive sector, are expected to be important drivers of growth.

Looming Risks and Tactical Views

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As many others have noted, one of the main weaknesses of the US economy lays in its corporates. In this matter, BlackRock was not an outlier, highlighting the falling profit margins and elevated levels of debt market.

Tactically, the strategist sees Japanese and Emerging market equities as cheap, taking an overweight view, as well as focusing on quality over value or momentum stocks. In fixed income, Thiel is underweight on German Bunds and Euro area peripherals, as well as global investment grade bonds, which he thinks are all expensive. He is however bullish on Emerging market bonds, both in local as well as in hard currency. However, of all the opportunities he saw, inflation was clearly the one Thiel was most enthusiastic about.

Inflation is Cheap

According to Thiel, protectionism, sustainability and climate change will be the dominant drivers of long-term inflation trends. Protectionism increases the cost of cross border trade, leading to increased prices once producers and retailers pass-on that cost to the end consumer. Sustainability, on the other hand, forces consumers to move away from cheap, but polluting or socially abusive products into more expensive but fair-trade alternatives.

Finally, climate change, if left unchecked will lead to an increase in the number of destructive extreme weather events. The destruction of crops and of the stock of physical and – sadly – human capital is in effect a supply shock, with inflationary effects. The process is expected to be self-reinforcing with desertification and increased temperatures adding reinforcing the negative productivity shocks. Moreover, the more regular occurrence of extreme weather events also means that these negative productivity shocks will also happen more often.

Taken together, these facts present the BlackRock strategistwith a very clear pro-inflationary trend going forward, which he proposes is ripe for clients to profit from on account of the fact that inflation assets are cheap. Taking his view, and since today’s 10-year breakeven inflation (1.64%) is in line with what its average over the last 10 years (1.96%) – which is not too far off from the actual annual inflation average over the same time period (1.77%) – the above analysis suggests that the market is underpricing future inflation and that investors might hop on board of the TIPS market.

 

Filipe Wallin Albuquerque
Filipe Wallin Albuquerque
Filipe is an economist with 8 years of experience in macroeconomic and financial analysis for the Economist Intelligence Unit, the UN World Institute for Development Economic Research, the Stockholm School of Economics and the School of Oriental and African Studies. Filipe holds a MSc in European Political Economy from the LSE and a MSc in Economics from the University of London, where he currently is a PhD candidate.

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