Multi-asset funds look for inflation hedges as Covid-19 heralds 'final disinflationary flourish'
Monetary stimulus brought into sharp focus
The coronavirus crisis "will very likely lead to a final disinflationary flourish", as some multi-asset investors look to hedge their funds against the potential return to an inflationary environment.
After a near-30-year period of benign inflation, fiscal and monetary stimulus have been used aggressively to defend economies against the effects of a Covid-19 downturn.
As a result, investors have been forced to contemplate higher levels of inflation once economic activity returns to normal.
The US and German governments, for instance, put together packages worth $2trn (£1.6trn) and €750bn (£645bn) respectively; the US Federal Reserve's balance sheet has ballooned to $6.5trn and the European Union has suspended debt and deficit requirements across its member nations.
This is likely to push US federal debt levels above 100% and close to a record high, according to Capital Economics' senior US economist Michael Pearce.
He said this "raise[s] the prospect that reducing debt will eventually require a mix of higher inflation and financial repression."
Indeed, the last time the Fed attempted to shrink its balance sheet, "there was carnage", recalled Charlie Morris, Atlantic House Investments' head of multi asset.
As a result, "it is a safe bet that the central bank balance sheets are upward-only mechanisms", which should lead to a world with excess liquidity.
"This is all happening at a time when austerity is off the table. Deficits are the new normal and key workers will ask for the pay rise they deserve.
"Maintaining the purchasing power of the currencies in your pocket will become a low priority for governments," Morris added.
Henry Neville, analyst for Man Group's DNA fund, went a step further, predicting Covid-19 would "lead to a final disinflationary flourish" before eventually giving way to inflation, as "policymakers are prompted towards pushing the red button" and modern monetary theory becomes the norm.
Others disagree. Salman Baig, multi-asset investment manager at Unigestion, accepted that in "normal economic times" it would be "logical" that government stimulus would push up goods prices; "but that is not the current situation we are in at all".
He cited parallels with the Fed's three rounds of post-financial crisis quantitative easing (QE), which caused expectations of inflationary pressures that never materialised.
"If you look at more contemporary examples, in Japan and Europe, often the stimulation by central governments is to offset a contraction in demand. That is what is going on here."
Markets seem to agree, with five-year, five-year forward inflation expectations (see chart, below) retracing from mid-March's 0.9% lows but standing only at 1.5% at the time of writing, well below their 2.4% peak in February 2018.
However, Vincent Ropers, co-manager of the Wise Multi-Asset Growth fund, countered Baig's comparisons with a decade ago, noting fiscal stimulus will be used more greatly today, mainly through infrastructure spending.
"This is potentially more inflationary than monetary stimulus, where inflation has been found to remain in the sphere of financial assets," Ropers noted.
"We have not got a crystal ball, but the combination of the largest and fastest monetary and fiscal stimulus packages globally with increased output costs and demand set to rebound relatively quickly seems like a good recipe for inflationary pressures to intensify over the next few years."
More on Multi-asset
Most read
