3 min read 6 Apr 22
In recent years, global authorities have tackled multiple crises through the deployment of huge fiscal and monetary firepower. This proved effective in supporting the financial system and the global economy during the global financial and euro sovereign debt crises and, more recently, in response to Covid-19.
Investors currently face a challenging landscape – from the war in Ukraine to the continuing impact of Covid in parts of the world, most notably China. Adding further complexity is high inflation, the recent emergence of which places policymakers in a dilemma. Whereas extreme fiscal and monetary measures were applied to recent crises, what has changed is the clear need to now consider the impact that policy measures could have on inflation.
The traditional focus of anti-inflation policies is demand. This could have limited impact in the current environment, since many aspects of the current inflationary episode can be attributed to the supply side.
Resurgent demand has clearly played a role in stoking inflationary pressures, but as economies are only just recovering from deep pandemic-induced recessions, attempting to rein in demand now might prove premature. Central banks appear to recognise that their ability to address the root causes of the current episode is limited, and consequently they may err on the side of continuing to support growth.
Policymakers are taking measures to counter inflation, reining in some of the super-accommodative monetary measures of recent years and raising interest rates. Markets anticipate further rate hikes will follow, however, real interest rates remain in unsustainably negative territory.
“There are only two mechanisms for that to unwind,” observes David Lloyd, Deputy Chief Investment Officer of Public Fixed Income at M&G. “One is for inflation to fall or the other is for interest rates to rise, starting of course with administered interest rates by virtue of central bank action by extension perhaps government bond yields going up with them.”
So, what role can patience play in an environment with multiple factors at play?
“It is astonishingly difficult to analyse the current situation and draw firm conclusions,” says Lloyd. “Arguably, making forecasts is a fool’s errand since not only is the outlook particularly uncertain, even if you were able to make an accurate prediction it wouldn’t necessarily help you have a clear view of the implications for asset prices.”
The value of investments will fluctuate, which will cause prices to fall as well as rise and investors may not get back the original amount they invested. Past performance is not a guide to future performance. The views expressed in this document should not be taken as a recommendation, advice or forecast.