Talking Point  

How to prepare portfolios for higher US inflation

How to prepare portfolios for higher US inflation

With US inflation now at a level which exceeds the market’s expectations, its prudent for clients to manage the risk this poses to portfolios, according to Willem Sells,chief investment officer at HSBC private bank and wealth management.

The latest US inflation data showed a rise of 5 per cent in May, the highest level since 2008, and the core inflation number, which is a data point that strips out the most volatile elements of inflation, showed an increase to over 3 per cent.

Sells said: “But the fact that core CPI also jumped more than expected indicates that there are factors besides oil and commodity prices at work, and that the outlook for inflation remains uncertain. Bottle necks in the supply chain and low inventories are causing input costs to rise, as we know from business surveys. And, although many businesses cannot charge through prices, some do. There is some wage pressure too, especially in retail and hospitality. The job numbers last week suggested that some workers are still reluctant to go back to work, which creates a shortage and pushes up wages. But as vaccinations continue and economies reopen, we believe that more people will find the confidence to go back to work and jobs will get filled. There are no signs of sharp broad-based wage inflation, and that is key for the outlook for US CPI. In our view, it is very unlikely that CPI will continue to drift up unless there is broad-based wage inflation.”

Economists generally believe that inflation caused by higher input costs, commonly called supply side inflation, is temporary in nature, as the market will always find ways to increase supply to meet demand, and as the extra supply comes into the system, prices stabilise or fall.

But if inflation is coming from factors additional to that, such as wage increases, then the path is less certain.

He says the market continues to believe that policy makers in the US view the currently very high inflation as transitory, and so will not respond to it by lifting interest rates. But he believes the inflationary pressures in the system is such that investors would be prudent to adjust portfolios to take it into account. 

In terms of what this means for portfolios, Sells says: “we continue to manage the risk of short-term rate-driven volatility. This means that we manage duration in bond portfolios, hold an overweight in financials, and look for diversification through gold and hedge funds. We also believe that portfolios that are very tech-heavy should look at diversifying into other sectors such as financials, consumer cyclicals, materials and industrials.”