For most of the last 20 years, we have lived in an environment where inflation has been structurally low. That era is now past tense across the developed world as inflation is back, including even in Japan.
“We have been seeing disinflation for several months and central banks may even undertake some of the rate cuts markets are hoping for, but I believe it would be wrong to assume that we are going back to familiar territory,” says John Butler, Macro Strategist, Wellington Management.
We could be returning to a world characterised by much more frequent and shorter cycles, with inflation that is structurally higher and more volatile. I see the likely road map for the next 10 years following a similar trajectory for two key reasons:
- Deglobalisation caused by geopolitical rivalry, concerns about the fragility of supply chains and the accelerating physical impact of climate change.
- Bigger labour share of income given governments’ intentions to address growing income disparity.
“This new paradigm has unsettling implications for asset prices and the correlation between assets. In particular, with cycles becoming shorter and more volatile, the correlation between equities and bonds is likely to fluctuate, thus reducing bonds’ reliability as a hedging asset in multi-asset portfolios. Asset prices also will have to adapt, and I foresee much more differentiation between countries and even sectors and companies,” says Butler.
“This new era may feel daunting, but it also offers a significant potential upside for discerning investors. For instance, I think current economic growth forecasts are too downbeat, and I expect growth to surprise on the upside. Even if much of that growth is nominal (owing to inflation) rather than real, it still may translate into attractive investment opportunities,” he says.
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