As per the Outlook Report 2021 by JP Morgan, “We expect inflation to rise modestly over the next 12 to 18 months to just below 2% in the United States and around 1% in Europe-right where it was for most of the last cycle. This means that policy rates will remain anchored, and investors should be wary of holding excess cash.”
Debates about the future path of inflation dominate investment conversations. That makes sense—inflation is a critical consideration for central bank policy and short and long-term interest rates. Of course, it also directly impacts the purchasing power of the cash in your wallet. Despite the debate, inflation was remarkably stable over the last decade.
In the past, high inflation has been a risk posing on economies. It was the central bank’s job to keep inflation down. As at today, the risk that prices won’t increase quickly or will fall is more realistic than the threat they will increase too fast, resulting in global central banks actively trying to push inflation higher rather than trying to keep them contained.
There is slack in the global economy, especially in the labour market. Based on the report, we find that ‘The number of permanently unemployed U.S. workers is still elevated – even as headline employment numbers recover. The digital economy does not have many physical constraints that lead to price hikes. Also, the lack of a ªblue waveº in the U.S. elections means that we likely won’t see a large-scale government spending program that might push prices higher. Further supply chain disruptions from de-globalization could put upward pressure on prices, but we would expect that process to play out over several years, if not decades. Central banks will need to remain supportive for the foreseeable future to keep inflation expectations roughly close to their targets.’
Indeed, a modest rise in inflation is likely going to be consistent with an improved global growth backdrop, and central banks wish to stoke inflation modestly higher. The Fed will eventually succeed but the path onwards will be slightly harder for ECB and Bank of Japan. Forward inflation expectations have already been recovered to pre COVID-19 levels in the US, however, are still below the Fed’s 2%+ target. At the same time, expectations in the Eurozone and Japan continue to remain depressed.
This is because policy rates are likely to remain close to zero for a few years. Excess cash is not an investors’ friend, and yield will be difficult to gain. In order to increase yield, investors can rely on US high yield bonds and preferred equities. In addition, there can be opportunities in assets that perform well even when inflation increases such as commodities, real estate and infrastructure.