Key takeaways
• A potential demand shock following Covid-19 developed into a supply shock.• A regime shift among energy markets and supply chains is the new fuel for global inflation.
• Going forward, we expect inflation to be higher and more volatile than in the past decade.
Inflation has come roaring back, fuelled at first by loose monetary and fiscal policies as central banks and governments aimed to combat a potential demand shock and expectations of high unemployment following the outbreak of Covid-19.
What eventuated instead was a supply shock due to a strong surge in durable goods purchases combined with manufacturing and shipping constraints as a result of global lockdowns. Russia’s invasion of Ukraine made matters worse, pushing up global energy, metals and agricultural commodity prices, and ultimately intensifying and broadening the global inflation problem.
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Global supply disruptions and the war in Ukraine have sparked a strategic rethink and structural regime shift among global energy markets and supply chains, with the green transition accelerating due to the energy crisis, and countries and companies now prioritising resilient, diverse and local supply chains over previous complex and cost-minimisation strategies. This regime shift is the new fuel for global inflation, leading to higher inflation and inflation volatility than we have seen in the past decade.
“Our tools don't really work on supply shocks. Our tools work on demand.”
US Federal Reserve chairman Jerome Powell, 4 May 2022.More resilient supply chains increase costs
First, global supply chains broke down during the initial impact of Covid-19 and are still under tremendous pressure, with the world’s largest port in Shanghai currently locked down.
The desire for cheap manufacturing labour was at the heart of globalisation; however, it led to significant dependencies on other nations and resulted in the majority of the world’s protective equipment, antibiotics, semiconductors and electric vehicle batteries being supplied from Asia.
In the wake of Covid-19, countries and companies have acknowledged that having complex global supply chains is a significant risk and are now re-shoring manufacturing (to higher manufacturing costs jurisdictions) or near-shoring manufacturing closer to customers or materials as well as holding higher inventories, so that their supply chains can be more resilient in the future.
“It’s hardly surprising that businesses, given what they are having to deal with, and the threats they are going through, are making adjustments. Inventory levels are going up …”
Bank of England governor Andrew Bailey, 28 March 2022.Second, the invasion of Ukraine has prompted a united willingness across Europe to end oil and gas imports from Russia and achieve energy independence, which has accelerated plans to install renewable energy capacity and electrify Europe’s industries, homes and transportation. By most estimates, this will require significant levels of sustained investment and raw materials, and this significant demand will drive a period of higher-for-longer commodity prices, which will likely be inflationary.
In our view, inflation will continue to surprise to the upside and will not revert to the subdued trends we became accustomed to in the decade before Covid-19 struck. Instead, inflation will be higher and more volatile, delivering stronger inflationary shocks than we have seen in the past decade.
“The energy transition (…) poses measurable upside risks to our baseline projection of inflation over the medium term.”
Executive ECB board member Isabel Schnabel, 8 January 2022.Portfolios should be prepared
We see the new inflationary regime that was initiated by central banks (accepting temporary overshoots of inflation and acting on actual rather than expected inflation data) and governments (increasingly deploying massive fiscal policy initiatives to support economies) now being continued by longer term structural drivers, such as the green transition, slowing globalisation, costlier manufacturing and supply chains, and ageing demographics.
As we have seen over the past 18 months, ordinary fixed income products suffer during periods of stagflation (rising inflation and falling growth), whereas inflation-linked bonds have performed well. If we are to face more inflationary shocks in the future, portfolios should be prepared.
For further information on our Global Inflation Strategies, please contact the Head of Global Asset Management Sales, Nicolaj Holm-Christiansen at nicch@danskebank.dk, the Head of Global Inflation and Chief Portfolio Manager, Christian Østerbye Vejen at chve@danskebank.dk, or Global Inflation Portfolio Manager Matthew Wells at mwel@danskebank.dk.
This publication has been prepared as marketing communication and does not constitute investment advice. Note that historical return and forecasts on future developments are not a reliable indicator of future return, which may be negative. Always consult with professional advisors on legal, tax, financial and other matters that may be relevant to assessing the suitability and appropriateness of an investment.
