Podcast: Aucune raison de craindre une dérive inflationniste (pour le moment)

Podcast: Aucune raison de craindre une dérive inflationniste (pour le moment)

30-03-2021 | Podcast
C'est inévitable : les plans massifs de relance budgétaire et la politique monétaire exceptionnellement accommodante que nous connaissons aujourd'hui entraîneront une augmentation de l'inflation. Mais selon Rikkert Scholten et Bob Stoutjesdijk, gérants de portefeuille au sein de l'équipe Global Macro Fixed Income de Robeco, les conséquences ne dureront pas. « De nombreuses et puissantes tendances de fond maintiennent l'inflation sous contrôle. » Découvrez pourquoi nos deux gérants ne sombrent pas dans l'alarmisme.


Erika van der Merwe (Erika): Bob and Rikkert, I'm going to call out some terms and you've got 10 seconds to explain to us what they mean. OK? Ready?

Male voice: This podcast is for professional investors only.

Erika: With the tidal wave of fiscal and monetary stimulus across the globe and particularly in developed markets, last year’s concerns about recession are now transforming into worries about economic overheating and a possible surge in inflation. The question now is: what will inflation do?

Male voice: Welcome to a new episode of the Robeco podcast.

Erika: We roped in two global macro specialists to answer the question. Rikkert Scholten and Bob Stoutjesdijk are portfolio managers in the Robeco Global Macro Fixed Income team. Welcome, gentlemen.

Bob Stoutjesdijk (Bob): Thank you.

Rikkert Scholten (Rikkert): Thank you.

Erika: Bob, it seems as though inflation has almost overnight become a critical topic for investors. What's happened and why are markets having these inflation jitters?

Bob: Indeed. Actually, we need to go back to the start of the pandemic last year. Markets really went down quite a bit. The economy also went down very strongly. And what did we see afterwards was basically that governments and also central banks stimulated (the economy) very strongly by lowering nominal yields, by announcing very big quantitative easing purchasing programs. And also the governments basically let their budget deficits rise and put money into the economy to basically support households and companies. And that mix of fiscal and monetary stimulus is being picked upon by the markets basically ever since the summer last year as the start of an inflationary trend. What is also important is that we're now at the brink also of the reopening of the global economy, given that we now have the vaccination, most countries also have a very proper vaccination strategy. So during the course of this year, the economies will reopen. So there will be a wave of pent-up demand for goods and services. Well, in combination with the perceived stimulus, [this] basically means that you have all the ingredients lined up for the expectation of an inflationary accident down the road.

Erika: ‘Inflationary accident’. That's quite an interesting term, Rikkert, so how serious are the numbers? What's the consensus inflation forecast right now?

Rikkert: Depends a little bit where you look. So if you look at the euro area, we currently have an inflation rate of 1% and the consensus expects [this] to rise towards 2%. So that is still relatively muted, also heading into this Covid period. Inflation was also close to 1%, so not that far away. If you look outside our borders, for instance, in the US, you see that more of an inflation hump is expected. There the current level of inflation is 1.7%. And it is expected, the consensus expects this to rise towards 3% and then roughly 2.5% at the end of the year. We actually think that inflation will be a little bit higher in the US. We see it rise more towards 3.5% and it's been a while. So they see a little bit more of a, let's say, opening-of-the-economy hump, base effect hump. But all and all the levers are at the moment still quite contained.

Erika: What about emerging markets, Rikkert? And I suppose it's a huge region if you say emerging markets. So China, for instance, how might that be different?

Rikkert: Well, at the moment, inflation is actually very low in China and CPI there is -0.2%. So it depends a little bit per country. And it's also very much dependent on food price inflation. Inflation in China was more than 5% only a year ago. So these swings in emerging economies are much more related to food prices and can be quite volatile.

Bob: And I would also add to emerging markets that what we're also seeing a little bit in some countries here and there is that obviously the pandemic has caused quite some economic and social damage in those countries. When you, for example, look at Brazil, when you look at South Africa, when you also look at the likes of Mexico, then you can see that they don't have the ability to physically stimulate the economy like we have done, for example, in developed markets. And that's now costing quite some social and economic pressure. So hence the politicians over there try to come up with more populist policies, which typically doesn't go well with investors. So what you're seeing over there is pressure on the currency to the downside, effectively also importing inflation via that channel. And that's also where you see some divides opening up in emerging markets.

Erika: So we talk about a consensus forecast for inflation. That's a typical term amongst investors. But there's clearly a great deal of debate about whether this rising inflation will be temporary or more structural. And there's also talk about the risk of policy error and financial instability. The debate between US economist Paul Krugman and Larry Summers as an example. And we'll get to that a little later in the conversation. And then the investor Ray Dalio argues that there are different types of inflation. Here he is in conversation with Bloomberg.

Recording of Dalio: The Federal Reserve would say we're just going above their inflation targets, not by much if you look at indicators like the break-even inflation rate, it's about 2.5% and they would say not yet. But the important thing to convey here on inflation is that there are two types of inflation, OK? I just want to make this clear. We're used to one type of inflation, which is when the economy is too hot, there is a capacity constraint. And when demand presses up against existing capacity, prices rise, unemployment rates are low and so forth. There is a thing called a monetary inflation. That's what you can have, stagflation. And that monetary inflation means that even when the economy weakens, inflation rates rise because there's too much inflation. And there's the move out of that.

Erika: Bob, having thrown that into the mix, let me ask you a more basic question. Why is inflation a key factor to be watched? And we know Ray was moving on to the implications for the bond market, but just generally speaking, for investors, why is this so important?

Bob: Well, inflation basically hits all financial assets. Inflation is also a driver of economic growth. So I think it's good to think about different kinds of various economic scenarios. But if you're living in a world where inflation is mild, so running around a target of 2%, that basically means that that in itself creates some demand out of itself. It creates demand for goods and services, it creates demand for labor and it keeps economic growth going. When you're looking, for example, more at inflation around zero or deflation, that means that people will postpone consumption. They save; limiting economic growth.

And on the other side, if inflation is running above the 2% or the target, then that basically means that real income is being lowered, so hence people can’t purchase and consume that in the way they want. And that then also leads to a weaker economic outcome. And that all implicates, has implications for the financial market broader. So if you're having very low inflation or deflation, then you will see an environment where interest rates are low. When you're having a higher inflation, then you will see interest rates higher than what we would now be seeing in the markets. And that impacts then, for example, also the valuation of equities or real estate, because interest rates are also used as an alternative investment/discount rate. So it affects everything and it also affects policy by central banks. It affects also fiscal policy, because if interest rates are very high, then that can also have implications for government’s inability to borrow in financial markets. So inflation and the type of scenario is everywhere.

Erika: So on this point, we checked in with our LinkedIn community to hear what the general view is on inflation. We asked readers to respond to the statement ‘Monetary and fiscal policies will cause a lasting rise in inflation.’ Now, about three-quarters of respondents agreed that this will indeed be the case. And of those who do expect high inflation, around two-thirds feel this is a real concern. So you can have a look at the Robeco LinkedIn page for the details on that survey. And I'll ask you a little later what you might have voted, if you looked at that. Rikkert, so often the inflation we experience in our personal lives seems not to be reflected in the official numbers, or, you know, what we read in the stats just doesn't follow through in the headline numbers. So how exactly is inflation measured?

Rikkert: Yeah, that's true. I think if you talk about, let's say, day-to-day confrontation with inflation, people often refer to things like gasoline prices or the prices in restaurants or bars; obviously a little bit less relevant at the moment. But it's important to note that these prices have a relatively small weight in the CPI basket. So the way inflation is measured is first of all defined by how people consume, so where they spend their money on, and that can vary from country to country and have different actions. For instance, in the US, rental inflation is a very important component of overall inflation. So, and currently rental inflation has an important dampening effect on the overall level there. So while any reopening of the economy in the US [means] we will probably see a rise in hotel prices, we will see a rise in airfares, these kind of products are very visible, but have a weight of less than 1%. The restaurant prices have already adjusted in the US to 3.7% inflation level. So there we  already see a bit of the re-opening effect. If you go to Europe, rents are also important, but to a smaller extent and the impact of energy prices is felt less directly in Europe than in the US. If you go to emerging markets, as mentioned earlier, there you see that food prices are very important and can have large swing in inflation levels. For instance, in a country like South Africa, food is 25% of the inflation basket. That's more than double the weight than we are used to here in a country like the Netherlands. And so there are important differences between countries and a lot of the inflation that is in the basket is not so visible in your day-to-day life.

Erika: Right, so I think this is a good point to pause and to challenge you on some of the jargon that you've used or some that we heard in some of the clips. We've designed a little flash quiz for you, just to be sure we all know what the smart economists are talking about. So, Bob and Rikkert, I'm going to call out some terms and you've got ten seconds to explain to us what they mean.

OK, ready?

Bob: OK.

Erika: Bob: core inflation.

Bob: That's the change in the cost of goods and services, excluding those from food and energy.

Erika: Rikkert: stagflation.

Rikkert: It's a period of high inflation in combination with low growth and high unemployment. Exceptional, like in the early 1980s.

Erika: Sounds painful, right? We want to avoid that at all costs.

Rikkert: Yeah, definitely.

Erika: Bob: reflation and asset price inflation.

Bob: Reflation is basically the process after a recession or a dip in the business cycle where inflation dips down and basically moves back to the long-term trend. And asset price inflation is basically the price increases in financial assets like stocks, bonds, real estate.

Erika: Is that the managed inflation that Ray Dalio was referring to?

Bob: Yes. Yup.

Erika: So, Rikkert, deflation versus disinflation, I always confuse the two and have to go back. So what's the difference and how do you remember which is which?

Rikkert: Well, deflation is negative inflation. So it’s a broad-based downward adjustment of price levels and disinflation means that the pace of inflation slows. So prices are still rising, but at a slower pace. So that’s the difference.

Erika: So if you go from, say, 3% inflation to 2.5% inflation, that would be disinflation.

Rikkert: Yeah, exactly. And it's also not the case that if you see prices of several goods decline, that that is necessarily deflation. What's meant by deflation is a series, it’s a broader-based, economy-wide decline in prices and that can have serious negative consequences because people will postpone their purchases, for instance.

Erika: Let's turn now to the recent very public statements by former US Treasury official Larry Summers questioning the wisdom of the hugely expansionary fiscal and monetary policy in the US. His recent column in The Washington Post was a boldly worded warning on this policy approach. Elsewhere, Summers has been particularly critical of Nobel laureate Paul Krugman’s very sanguine view on the inflation implications of these policies. Here are some brief extracts from Bloomberg Wall Street week that gives a sample of their opposing views. The first voice is Krugman. The second is Summers.

Recording of Krugman: …on balance is probably somewhat inflationary because some of that increased spending will spill over to other stuff. But it's not nearly as much as you're just looking at the growth numbers is not getting you the whole story. We right now have an economy that is depressed in part because of supply constraints that will go away as the vaccination spreads.

Recording of Summers:I think there's about a one-third chance that inflation will significantly accelerate over the next several years and will be in a stagflationary situation. I think there’s a one-third chance that we won't see inflation, but that the reason we won't see it is that the Fed hits the brakes hard, markets get very unstable, the economy shifts downwards close to recession. But there are more risks in this moment that macroeconomic policy itself will cause grave consequences than I can remember.

Erika: Rikkert, how would you respond to that? So I understand that the disagreement between them goes deeper than inflation. And it's really about, you know, the policy approach more fundamentally. But inflation is such a core element to that. So how do you respond to that? Do you agree that like Krugman says, it's temporary, it'll go away? [Or] where Summer says, no, there's a major risk here?

Rikkert: Yeah, well, Summers has a point. I mean, a lot of money has been thrown at the economy and which makes that people have been able to save a lot despite the Covid crisis. And not everybody, of course. But in Europe, the average household was able to save four thousand euros last year. In the US, the average household was able to save more than twenty thousand dollars last year. And of course, that's only the average. And there are a lot of people who are not able to save. But that means there is, there has been an overstimulance of the economy more than just a bridging; that is clear. Will that have lasting effect, impact, on inflation? Yeah, I think that remains to be seen. Of course, we will see the impact of higher oil prices. Of course, we will see that hotels and restaurants will continue to, will lift their prices and airfares will go up. But this is probably a temporary effect. If you want to see lasting inflation at the higher level, the first thing you want to see is higher wages. And if you then look how wages have developed over the past decades, it really takes a substantial decline in unemployment, at least a five percentage point decline in unemployment, before you get into serious, let's say, shortages in the labor market. And, of course, there will be parts where there will be shortages, but on average, we are not there yet.

Bob: And I would also add to that and I'm not picking the side of Krugman, but his central point is also based on the idea that all the stimulus that we have seen so far is basically compensation for a very bleak economic period. It's not stimulus in a typical textbook format, that you really put money into the hands of people who are facing a very strong labor market and really strong economic growth. It's more you keep incomes live in a very bleak time. And that in itself doesn't lead to this wage spiral that Rikkert just referred to.

Erika: OK, so what I'm hearing is you have no concerns about any cyclical drivers pushing inflation higher in any kind of lasting way. But what about the structural factors? Because meanwhile, there are a number of factors going on. We've heard, you know, how globalization helped reduce inflation worldwide. And now that seems to be reversing. And it's as though Covid might have accelerated that process of reversing globalization.

Rikkert: Yeah, true. But it's not as if you were at peak globalization going into this crisis. Let's be clear about that. I think if you look at the global trade, that was growing at very high levels at the time the Chinese economy was starting to open up for global trade. So that was around, let's say, 2000 to 2005. But after the great financial crisis of the past decade, we already saw that there was a significant slowdown in global trade growth. It was still growing, but at a slower pace. Still, did we experienced a rise in inflation from that moderation? I would say no. And also, if you look at what globalization has brought in terms of reducing inflation; there are some studies around that, for instance, by the Banque de France, and you will see that they conclude that inflation was only, let’s say, depressed by a 0.25% per year because of globalization. So any reversal of globalization, will that have a huge impact? Well, yeah, the academics doubt that.

Erika: OK, so let's move to the ‘so what’. Given your views on inflation and for me, bottom line is you're not worried about it – it's going to be temporary – how do you expect central banks then to react to rising inflation? And so we also keep hearing about the taper tantrum. Perhaps you can explain what that means. What's the outlook then for central bank policy action here?

Rikkert: So let's start with the Fed.

Bob: Yep.

Rikkert: And I think the Fed will welcome it. They – last year, they changed their monetary policy framework, their goal. And actually, they welcome higher inflation and they welcome our, even an overshoot of inflation above their 2% target. Why? Because they are afraid that these lower inflation expectations will otherwise, let’s say, be sticky, be embedded in people's thinking. So first of all, if inflation rises, they will be happy. And so they will do nothing, they keep their policy as it is. But obviously, there are different layers in their policy here, now, next to keeping rates at zero, they also purchase a significant amount of bonds. And we do think that as the economy reopens and especially as unemployment starts to decline, and that could happen relatively soon, that they will at some point in time signal that they will reduce their purchases of bonds. And that might only start to happen next year. But that signalling: that is what you were referring to, Erika, about taper tantrum. We saw in 2013 that the signalling that they would reduce their bond purchases had a significant impact on bond prices and resulted in rising interest rates. And now something like that is happening a little bit at the moment with people anticipating a reopening of the economy. But the Fed has not signalled yet that they are contemplating on reducing their bond purchases. So that is something that could still hit the market. We expect it, that could take place, in, say, the coming quarter.

Bob: Going back a little bit to the central banks, I think for the ECB and the likes for the Bank of Japan, they would really love inflation. I think they would be very jealous on the US where you can clearly see that from a cyclical perspective and also from a longer term out, that countries much more inflation prone, for them that's quite different. So they will probably stick to their current policy mix, which basically means indicating that they, if needed, they can cut rates further because simply both countries really, really struggle with a mix of very high levels of debt, both corporate and public debt and an aging problem. So the demographics are really against those countries. And in that sense, they are less inflation prone. So for the ECB and the BOJ, we basically expect that they will keep their current policies in place, be it that some of the pure pandemic policies at some stage might be phased out. But also there, that's more longer term out. For emerging markets, there it also really matters what the Fed is doing, because in that sense, also the Fed is a little bit the central bank of the world, especially for emerging markets, given their strong link with the dollar. But there we would also think that, for example, a potential taper announcements can be quite negative for emerging markets because then on their taper announcement or a taper expectation, nominal rates would increase in the US. So funding rates would go up for also emerging markets because they simply borrow a lot in dollars. And that in itself might trigger some weakness over there.

Erika: Right. I can't let you go without asking you what would you have voted or what perhaps maybe you did go and vote on the Robeco LinkedIn account to our poll. So just remind you, the question was, ‘Globally, monetary and fiscal policies will cause a lasting rise in inflation.’ There was  ‘Agree – and it's a good thing’, ‘Agree – and it’s a concern’ or ‘Disagree’. Rikkert and Bob, how would you have voted?

Bob: Well, I actually voted on this one, and I disagreed because our framework is basically saying, well, we're going to now face the cyclical time where we're going to see this rising inflation because of temporary effects. The lasting rise in inflation – and for me, inflation is, I think, more comparable to inflation, like we've seen, for example, in the 80s, so that you really have a large inflation overshoot – I don't see that probability as being very high for the near term. But I do recognize that, ever since the GFC [global financial crisis], policy both from the central banks and from the government, have been pointing towards more budget deficits, more money printing, more fiscal easing. So I do recognize that in due time and perhaps we need another big crisis for it, that this combination can lead to an inflationary accident. But that's still, I think, a decade away at minimum, simply because there are a number of very strong secular forces out there still, that keep inflation contained.

Rikkert: Yeah, I think it's a word ‘lasting’, indeed, that will make me to vote ‘Disagree’. I think there will be an inflationary impact from current policies, but indeed it'll be on the more shorter-term horizon. And let's be clear, it's very good that these, in my opinion, that these monetary and fiscal stimulus are in place because imagine where we would be without them. So, but I think the impact will be more and more temporary.

Erika: And then bringing it home to a really practical level above. Bob, I'll ask you, given your inflation views, how are you positioning your global fixed income portfolios?

Bob: Well, we recognize the inflation scare in markets and the potential tapering it might bring so that means that we are underweight duration in a number of markets in our portfolio like the US and the UK, for example. In a broader setting, also the exit or the potential exit of central bank policy and the tapering announcement also makes us believe that we want to be underweight credits simply because of very tight level of spreads. Furthermore, also emerging markets isn't a category in our universe where we are very conservative about simply because we doubt whether they have a sufficient amount of room to stimulate their economies and we expect some further weakness over there.

Erika: Well, Bob Stoutjesdijk, Rikkert Scholten: thank you so much for your thoughtful insights. It's been hugely informative.

Bob: My pleasure.

Rikkert: My pleasure, thank you.

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