For professional investors in Brazil

Inflation: no rerun of that ’70s show

Andrew Mulliner, CFA

Andrew Mulliner, CFA

Head of Global Aggregate Strategies | Portfolio Manager


Helen Anthony, CFA

Helen Anthony, CFA

Portfolio Manager


3 May 2022

Key takeaways:

Andrew Mulliner and Helen Anthony, portfolio managers within the Global Bonds team, believe that inflation is much less rooted than the recent central banker rhetoric would indicate, and that conditions are ripe for a near-term moderation in price rises.

 Key takeaways

  • The recent pace of growth in money supply indicates that inflation is poised to fall as pandemic-related monetary support runs its course.
  • Current drivers of inflation still hark back to the pandemic’s supply disruption and energy market volatility.
  • Spending behaviour and long-term inflation expectations indicate that consumers still view inflation as transitory.

 

Recently, it feels like the talk of inflation is all consuming. From grocery stores to the front pages of every financial newspaper, rising prices – and their impact on daily lives – are on everyone’s mind. One only has to do a quick Google Trends search to see that since the mainstream adoption of the internet, our current collective awareness of inflation is truly off the scales (figure 1).

 Figure 1: Internet search trends show unprecedented interest in rising prices

Source: Janus Henderson Investors, Google Trends, as at 26 April 2022.
Note: Interest over time numbers represent search interest relative to the highest point on the chart for the given region and time. A value of 100 is the peak popularity for the term. A value of 50 means that the term is half as popular. A score of 0 means there was not enough data for this term.

Perhaps most ominously for investors, what used to be couched as a ‘transitory’ post-COVID price reversion has now started to sound much more rooted in policymaker rhetoric. Markets have priced in this change of attitude and are now bracing for a sharp tightening of monetary conditions from central bankers looking to regain credibility after a year of inflation ‘surprises’ and accelerating price rises.

Faced by this once-in-a-generation phenomenon, commentators have started to look back in time to the inflationary wave of the 1970’s for clues about what could befall markets. While it is easy to draw parallels with the 70’s oil-induced inflation initially, a closer look at the drivers of recent price rises shows that the script for this latest wave of inflation is different. We believe that policy mistakes from central bankers pose the greatest risk to the economy right now. In short, we are more worried about the US Federal Reserve than we are about inflation.

No 70’s replay

The main argument against a rerun of the 70’s style inflation is monetary. What drove prices five decades ago was a sustained and significant increase in the money supply. While it is true that policies enacted to address the pandemic did cause the supply of money to rise at the fastest rate since the 70’s, these have either run their course or been rolled back, which in turn triggered a sharp deceleration in the growth of new money over recent months.

Figure 2: Money supply growth has fallen as post-COVID monetary support rolls off

Source: Janus Henderson Investors, Economic Adviser Simon Ward, Refinitiv Datastream, as at 28 February 2022.

We also see no repeat of the credit-led money creation of the 70’s. In fact, bank lending activity has remained below the long-term average throughout the pandemic.

Historically, it has taken three years (33 months) for adjustments in the supply of money to be reflected in consumer prices. By this measure, inflation is already primed to retreat – right at the time that policymakers are starting to become much more militant about fighting it. This in our view, raises the prospects that central bankers will tighten too far, too fast, which could cause significant harm to economic growth and trigger more market volatility.

Causes of inflation not entrenched

We see the underlying cause of recent inflation as much less entrenched than the hawkish tone taken by central bankers would warrant.

If we analyse the factors driving inflation since the pandemic, it is evident that a significant portion is attributable to energy, food and goods – which all remain plagued by pandemic-related bottlenecks, rising oil prices and, more recently, conflict in Ukraine. These sharp increases have all started to be reflected in the core inflation readings that usually instruct the views of policymakers looking to strip out volatile elements of the inflation picture that are not easily swayed by monetary policy.

Figure 3: US CPI data show inflation remains driven by COVID-related supply shocks

Source: Janus Henderson Investors, Bloomberg, as at 28 February 2022.

We note that services inflation – which had contributed the lion’s share of inflation in the runup to the pandemic – has remained much more in line with long-term trends, even if it has started to tick up in recent months.

Although there is no hiding the fact that recent price increases have been broad, we still think that the true underlying causes remain transitory and linked to the nature of the shock that the pandemic imposed on the economy.

We recognise that further inflation could trigger an ‘adaptive expectations’ feedback loop where workers factor in persistent inflation in their wage settlement negotiations but expect this risk to moderate in the coming months as the bottlenecks that have been driving recent price rises start to ease.

The Federal Reserve Bank of New York’s consumer inflation expectation survey reflects this transitory view on inflation, showing that consumers expect inflation to moderate to 4% on a three-year horizon – significantly less than the 6% short-term expected inflation for the coming year. Long-term inflation expectations have also started to retreat from recent highs (figure 4).

Figure 4: Long-term consumer inflation expectations remain stable

Source: Janus Henderson Investors, Federal Reserve Bank of New York, Survey of Consumer Expectations, Bloomberg, as at 28 February 2022.

Recent consumer sentiment surveys are also signalling that an easing of inflationary pressure is on the cards. The University of Michigan consumer sentiment survey has been trending at its lowest level since the financial crisis, indicative of a near-term drop in demand that would be deflationary in nature. Additionally, survey data show that consumers have been putting off large purchases, the opposite of what is usually seen when consumers expect further price rises and try to bring forward purchases to pre-empt price rises (figure 5).

Figure 5: Consumer sentiment negatively impacted by inflation

Source: Janus Henderson Investors, University of Michigan (UoM) surveys of consumers, index values, as at 31 March 2022.


Policy risk

The challenge presented to policymakers in this round of tightening is that they will be pulling on levers that impact on demand to try and address transient supply problems, which are largely exogenous to the monetary system. Threading the needle between rolling back the post-COVID monetary support while keeping growth on track will prove tricky.

Although some of the recent policymaker rhetoric can be attributed to a desire to regain credibility after having kept rates low for so long in this cycle, the risks that inflation continues to overshoot their targets cannot be ignored. However, we believe that these risks will fade in the near term as the erosion of consumer spending power and the conflict in Ukraine start to weigh on growth forecasts. In turn, we expect to see a dialling back of the hawkish language, which should relieve some of the recent market uncertainty.

 

 

Glossary

Adaptive expectations: this is an economic theory which gives importance to past events in predicting future outcomes. A common example is for predicting inflation. Adaptive expectations state that if inflation increased in the past year, people would expect a higher rate of inflation in the next year.

Inflation: the rate at which the prices of goods and services are rising in an economy. The CPI and RPI are two common measures. The opposite of deflation.

Hawkish: an aggressive tone. For example, if the US Federal Reserve uses hawkish language to describe the threat of inflation, one could reasonably expect stronger action from the central bank. Opposite of ‘dovish’.

Monetary policy: the policies of a central bank, aimed at influencing the level of inflation and growth in an economy. It includes controlling interest rates and the supply of money. Monetary stimulus refers to a central bank increasing the supply of money and lowering borrowing costs. Monetary tightening refers to central bank activity aimed at curbing inflation and slowing down growth in the economy by raising interest rates and reducing the supply of money.

Money supply: money supply is the total amount of money within an economy. The narrow definition of money supply includes notes and coins in circulation and money equivalents that can be converted into cash easily. The broader definition includes various kinds of longer-term, less liquid bank deposits.

Volatility: the rate and extent at which the price of a portfolio, security or index, moves up and down. If the price swings up and down with large movements, it has high volatility. If the price moves more slowly and to a lesser extent, it has lower volatility. It is used as a measure of the riskiness of an investment.

 

 

These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.

 

Past performance does not predict future returns. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

 

The information in this article does not qualify as an investment recommendation.

 

Marketing Communication.

 

Glossary

 

 

 

Important information

Please read the following important information regarding funds related to this article.

The Janus Henderson Horizon Fund (the “Fund”) is a Luxembourg SICAV incorporated on 30 May 1985, managed by Henderson Management S.A. Henderson Management SA may decide to terminate the marketing arrangements of this Collective Investment Scheme in accordance with the appropriate regulation. This is a marketing communication. Please refer to the prospectus of the UCITS and to the KIID before making any final investment decisions.
    Specific risks
  • An issuer of a bond (or money market instrument) may become unable or unwilling to pay interest or repay capital to the Fund. If this happens or the market perceives this may happen, the value of the bond will fall.
  • When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise. This risk is generally greater the longer the maturity of a bond investment.
  • The Fund invests in high yield (non-investment grade) bonds and while these generally offer higher rates of interest than investment grade bonds, they are more speculative and more sensitive to adverse changes in market conditions.
  • Callable debt securities, such as some asset-backed or mortgage-backed securities (ABS/MBS), give issuers the right to repay capital before the maturity date or to extend the maturity. Issuers may exercise these rights when favourable to them and as a result the value of the fund may be impacted.
  • The Fund may invest in onshore bonds via Bond Connect. This may introduce additional risks including operational, regulatory, liquidity and settlement risks.
  • The Fund may use derivatives towards the aim of achieving its investment objective. This can result in 'leverage', which can magnify an investment outcome and gains or losses to the Fund may be greater than the cost of the derivative. Derivatives also introduce other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
  • If the Fund holds assets in currencies other than the base currency of the Fund or you invest in a share/unit class of a different currency to the Fund (unless 'hedged'), the value of your investment may be impacted by changes in exchange rates.
  • When the Fund, or a hedged share/unit class, seeks to mitigate exchange rate movements of a currency relative to the base currency, the hedging strategy itself may create a positive or negative impact to the value of the Fund due to differences in short-term interest rates between the currencies.
  • Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.
  • Some or all of the ongoing charges may be taken from capital, which may erode capital or reduce potential for capital growth.
  • The Fund may invest in contingent convertible bonds (CoCos), which can fall sharply in value if the financial strength of an issuer weakens and a predetermined trigger event causes the bonds to be converted into shares of the issuer or to be partly or wholly written off.
  • The Fund could lose money if a counterparty with which the Fund trades becomes unwilling or unable to meet its obligations, or as a result of failure or delay in operational processes or the failure of a third party provider.
  • In addition to income, this share class may distribute realised and unrealised capital gains and original capital invested. Fees, charges and expenses are also deducted from capital. Both factors may result in capital erosion and reduced potential for capital growth. Investors should also note that distributions of this nature may be treated (and taxable) as income depending on local tax legislation.
  • The Fund invests in Asset-Backed Securities (ABS) and other forms of securitised investments, which may be subject to greater credit/default, liquidity, interest rate and prepayment and extension risks, compared to other investments such as government or corporate issued bonds and this may negatively impact the realised return on investment in the securities.
The Janus Henderson Horizon Fund (the “Fund”) is a Luxembourg SICAV incorporated on 30 May 1985, managed by Henderson Management S.A. Henderson Management SA may decide to terminate the marketing arrangements of this Collective Investment Scheme in accordance with the appropriate regulation. This is a marketing communication. Please refer to the prospectus of the UCITS and to the KIID before making any final investment decisions.
    Specific risks
  • An issuer of a bond (or money market instrument) may become unable or unwilling to pay interest or repay capital to the Fund. If this happens or the market perceives this may happen, the value of the bond will fall. High yielding (non-investment grade) bonds are more speculative and more sensitive to adverse changes in market conditions.
  • When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise. This risk is generally greater the longer the maturity of a bond investment.
  • Callable debt securities, such as some asset-backed or mortgage-backed securities (ABS/MBS), give issuers the right to repay capital before the maturity date or to extend the maturity. Issuers may exercise these rights when favourable to them and as a result the value of the fund may be impacted.
  • Emerging markets expose the Fund to higher volatility and greater risk of loss than developed markets; they are susceptible to adverse political and economic events, and may be less well regulated with less robust custody and settlement procedures.
  • The Fund may invest in onshore bonds via Bond Connect. This may introduce additional risks including operational, regulatory, liquidity and settlement risks.
  • The Fund may use derivatives towards the aim of achieving its investment objective. This can result in 'leverage', which can magnify an investment outcome and gains or losses to the Fund may be greater than the cost of the derivative. Derivatives also introduce other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
  • If the Fund holds assets in currencies other than the base currency of the Fund or you invest in a share/unit class of a different currency to the Fund (unless 'hedged'), the value of your investment may be impacted by changes in exchange rates.
  • When the Fund, or a hedged share/unit class, seeks to mitigate exchange rate movements of a currency relative to the base currency, the hedging strategy itself may create a positive or negative impact to the value of the Fund due to differences in short-term interest rates between the currencies.
  • Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.
  • The Fund may incur a higher level of transaction costs as a result of investing in less actively traded or less developed markets compared to a fund that invests in more active/developed markets. These transaction costs are in addition to the Fund's Ongoing Charges.
  • Some or all of the ongoing charges may be taken from capital, which may erode capital or reduce potential for capital growth.
  • The Fund may invest in contingent convertible bonds (CoCos), which can fall sharply in value if the financial strength of an issuer weakens and a predetermined trigger event causes the bonds to be converted into shares of the issuer or to be partly or wholly written off.
  • The Fund could lose money if a counterparty with which the Fund trades becomes unwilling or unable to meet its obligations, or as a result of failure or delay in operational processes or the failure of a third party provider.
  • In addition to income, this share class may distribute realised and unrealised capital gains and original capital invested. Fees, charges and expenses are also deducted from capital. Both factors may result in capital erosion and reduced potential for capital growth. Investors should also note that distributions of this nature may be treated (and taxable) as income depending on local tax legislation.