Inflation has become a hot topic. Friedrich von Hayek likened controlling it to catching a tiger by the tail. Are UK investors making a grab for this least friendly of cats?
As Bank of England chief economist Andy Haldane said: “For many years, the inflationary tiger slept,” though now the “combined effects of unprecedentedly large shocks, and unprecedentedly high degrees of policy support, have stirred it from its slumber”.
Like any good economist, however, he hedges his bets, as “it would be spuriously precise” to assign probabilities to either inflationary or deflationary outcomes.
That does not stop the Monetary Policy Committee, on which Haldane sits, estimating a one-in-three chance of inflation lying below zero, or above 4 per cent, at its two-year policy horizon. Perhaps this is the committee’s idea of ‘validly imprecise’.
Since the fourth quarter of 2020, the inflationary drums have been beating louder.
A recovery from Covid is expected to unleash pent-up demand, as we all rush out on holiday, get our hair cut, and gorge on restaurant fare. Asset prices have bounced back, the most dramatic example being that of oil, where WTI Crude went from almost minus $37 (£27) a barrel in April 2020 to more than $60 and climbing.
Then there is the vast government spending to support the economy. The US has spent 30 per cent of US GDP on Covid support, compared to 5 per cent in the aftermath of the global financial crisis. And there is more to come, with the US rolling out a $1.92tn recovery plan.
However, this side of the pond, there is not much sign of inflation yet, as you can see from the chart below. It is ticking up, but from a very low base.
Writing in the Financial Times, Jeremy Siegel, professor of finance at the Wharton School of the University of Pennsylvania, warned “higher inflation is coming, and it will hit bondholders”.
Inflation reduces the real value of fixed income streams, so it is bad for bond investors. “It will be the Treasury bondholder, through rising inflation, who will be paying for the unprecedented fiscal and monetary stimulus over the past year,” said Siegel.
Investors can respond to this through a combination of cutting bond exposure, shortening duration, and switching from conventional to inflation-linked bonds. The broad rally following last April’s collapse was followed by a degree of caution in September as money went into longer-duration bond funds.
For much of 2020, governments and central banks were firefighting the pandemic, so that is no surprise: back in September, few were fretting about inflation, bounce or no bounce. Then, the end was far from nigh, pandemic-wise, and Joe Biden was still nowhere near the White House. Things have changed – but have investor expectations?
That certainly seems to be the case in the US. Refinitiv Lipper research for the US market showed net flows into inflation-protected bonds funds for both January (+$5.9bn) and February (+$3.6bn). These were record amounts going back 2002, when this classification was created.