Why we are worried about persistent inflation

TL;DR

• One key market risk for 2022 is how persistent inflation proves to be. This will also determine how much central banks globally choose to respond by raising interest rates.
• We expect inflation to remain far more persistent than usual. This is driven by structural trends including labour market mismatches, the surge in digitalisation, and decarbonisation.
• This inflation backdrop could lead the Fed to hike rates by at least two times in 2022.
• If investors are concerned about inflation, they should own assets in their portfolios that would enable them to hedge against higher prices.

What happened?

Inflation rates going up. Price pressures and supply-side shortages have manifested themselves in a number of ways over the course of this year. Some of the areas where they have shown up include higher container shipping rates, an acute shortage of labour, and a surge in energy price. Evidently, inflation rates have gone up in many developed markets. How central banks choose to react to the inflation could could become a key macro risk in the next year.

What does this mean?

• Temporary and structural drivers of higher inflation. Inflation pressures are a result of unusually high goods sector demand running up against supply-side bottlenecks such as in labour, energy and semiconductors, coupled with manufacturing and port disruptions. These are in turn driven by a mix of temporary factors (eg. COVID-19 disruptions and fiscal stimulus) but also longer-term structural trends which will be with us for some time to come (eg. digitalisation, decarbonisation and labour shortages).
• Inflation likely to be persistent. We continue to think that inflation pressures next year will prove to be more persistent than many observers expect, with upside risks potentially coming if energy prices rise further. As such, we think the Fed will likely raise interest rates as we move through next year.
• Interest rates hikes widely expected. The market has already started to price at least two hikes by the Fed for 2022, which means that some of the tighter monetary policy has already built into the market’s expectations

What would Beansprout do?

If investors are concerned about inflation, they should own assets in their portfolios that would enable them to hedge against higher prices. This would be asset classes that have limited supply as a higher demand for these assets would drive higher prices as well.

• Commodities – From oil to copper to palm oil, the prices of many commodities are now close to multi-year highs. ETFs that offer exposure to oil are USO, while ETFs like DBC offer broader commodities exposure.
• Gold – Gold has been seen as an inflation hedge for decades as its supply cannot be increased within a short span of time. ETFs that offer exposure to gold include GLD or GDX. For those looking at silver as an alternative to gold, ETFs that offer exposure are SLV and SIL.
• Cryptocurrencies – One of the key attributes of Bitcoin is its limited supply of 21,000, which has led to it also being known by some as “digital gold”.