hongkongen
Inflation is not dead, it’s just shifted direction

Inflation is not dead, it’s just shifted direction

07-09-2017 | Monthly outlook

Inflation can never be eradicated and so central banks will pursue targets for it, even as prices fall, says Lukas Daalder

  • Lukas Daalder
    Lukas
    Daalder
    CIO Robeco Investment Solutions

Speed read

  • Main central banks have an inflation target of around 2%
  • Structural changes have consistently lowered prices
  • Inflation has moved into assets from goods and services

Some economists argue that persistent disinflation – and the greater threat of deflation – means central banks should either abandon their common 2% target or replace it with a lower one. It follows a growing belief that monetary policy led by quantitative easing has been ineffective in creating inflation to drive economic growth.

But this is not necessarily the way to go, says Daalder, Chief Investment Officer of Robeco Investment Solutions. He says inflation is still around, though it is now seen in the prices of financial assets rather than the more traditional goods and services.

Central banks seem likely to stick to 2% as their inflation target, even though it is not based on academic research as being optimal, but was in fact arbitrarily chosen by New Zealand in 1989. The European Central Bank, US Federal Reserve, Bank of Japan and Bank of England all continue to target 2%, even though inflation in their respective jurisdictions has consistently been below that for most of the past decade.

The structural decline in inflation seems hard to miss. Source: Robeco

Why inflation has fallen

Daalder says there are many arguments as to why the threat of inflation – which decades ago was in double digits and destabilized entire economies – has so dramatically lowered in the modern age. One is digitalization, which has revolutionized industries such as the media, photography and music and made it possible to produce extra copies of news items, games or songs at virtually zero cost.

Another is the loss of the market power of labor, following the demise of unions, globalization and the ongoing automation of formerly labor-intensive industries. Aging populations are also deflationary, since older people tend to save more and spend less. Meanwhile, oil has lost its power to move markets as other forms of energy such as shale gas and solar power have steadily weakened the oil price.

“All of these arguments point in the direction that inflation has been structurally lowered, a theory which is also supported by the inflation data we have seen in recent years,” says Daalder. “This raises the question of what happens if central banks continue to aim for an inflation rate of around 2%, while the mechanics of the modern-day economy prevent it from ever reaching that.”

A ‘monetary phenomenon’

“The economist Milton Friedman once said: ‘Inflation is a monetary phenomenon. It is made by or stopped by the central bank.’ In that case, why have the central banks been unsuccessful in reaching the 2% target? Normally, an increase in liquidity would have resulted in ‘too much money chasing too few goods’, to once again quote Friedman, leading to inflation. Why hasn’t this inflation materialized?”

“The answer is that this inflation has in fact materialized, but not in the sphere of goods and services, but rather in the realm of financial markets. The strong rebound seen in real estate markets; the fact that the S&P 500 is trading at a Shiller PE of 30.3x; and abnormally low bond yields (which means high bond prices) can all be seen as a reflection of inflated financial asset prices. As these assets are not included in the inflation target of central banks, we do not see them as inflationary, though.”

Alternative views

Daalder says a different group of economists accept these arguments for why disinflation has occurred, but prefer to focus on the risks involved with the decline in inflation, and future expectations for it, and deal with that instead. They primarily cite the loss of effectiveness of monetary policy in being able to create inflation, using the interest rate as the main weapon, as an indication that other methods are necessary.

They also argue that wages are traditionally sticky to the downside, where it is easier to fire people than adjust wages lower, potentially harming the economy. And letting inflation drift lower means the real level of debt steadily rises over time (assuming interest rates stay the same); someone taking out a 30-year mortgage assuming a 2% inflation rate would face a higher debt burden if inflation structurally drifts lower.

“Looking at the statements of various central banks officials, it appears that most of them can be considered to be in the second camp,” says Daalder. “This seems to point in the direction of the boom-bust scenario: central banks pushing too much liquidity in the system creates ‘inflation’ in all of the wrong places.”

“There is a more positive scenario possible as well, though: the scenario in which ordinary inflation will return, albeit it with a delay. “We are somewhat reluctant to embrace the ‘inflation is dead’ line of thinking,” says Daalder. “This is partly because we have seen these claims more often in the past – they remind us a bit too much of the ‘the business cycle is dead’ claim that resurfaces every ten years or so – but partly also because we do not believe that inflation can ever be eradicated.”

“As long as supply and demand do not perfectly match, inflation will remain part of our system. We can particularly see tightness returning in labor markets, with demand outstripping supply. Technological change may have postponed wage increases, but we do not see why it will not come eventually. In this scenario – our base case – inflation will return after some delay, and with it bond yields are expected to rise as well.”

Important information

The contents of this document have not been reviewed by the Securities and Futures Commission ("SFC") in Hong Kong. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice. This document has been distributed by Robeco Hong Kong Limited (‘Robeco’). Robeco is regulated by the SFC in Hong Kong.
This document has been prepared on a confidential basis solely for the recipient and is for information purposes only. Any reproduction or distribution of this documentation, in whole or in part, or the disclosure of its contents, without the prior written consent of Robeco, is prohibited. By accepting this documentation, the recipient agrees to the foregoing
This document is intended to provide the reader with information on Robeco’s specific capabilities, but does not constitute a recommendation to buy or sell certain securities or investment products. Investment decisions should only be based on the relevant prospectus and on thorough financial, fiscal and legal advice. Please refer to the relevant offering documents for details including the risk factors before making any investment decisions.
The contents of this document are based upon sources of information believed to be reliable. This document is not intended for distribution to or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.
Investment Involves risks. Historical returns are provided for illustrative purposes only and do not necessarily reflect Robeco’s expectations for the future. The value of your investments may fluctuate. Past performance is no indication of current or future performance.

Disclaimers

1. General
Please read this information carefully.

This website is prepared and issued by Robeco Hong Kong Limited ("Robeco"), which is a corporation licensed by the Securities and Futures Commission in Hong Kong to engage in Type 1 (dealing in securities); Type 4 (advising in securities) and Type 9 (asset management) regulated activities. This website has not been reviewed by the Securities and Futures Commission or any regulatory authority in Hong Kong.

2. Important risk disclosures
Robeco Capital Growth Funds (“the Funds”) are distinguished by their respective specific investment policies or any other specific features. Please read carefully for the risks of the Funds:

  • Some Funds are subject to investment, market, equities, liquidity, counterparty, securities lending and foreign currency risk and risk associated with investments in small and/or mid-capped companies.
  • Some Funds are subject to the risks of investing in emerging markets which include political, economic, legal, regulatory, market, settlement, execution, counterparty and currency risks.
  • Some Funds may invest in China A shares directly through the Qualified Foreign Institutional Investor (“QFII”) scheme and / or RMB Qualified Foreign Institutional Investor (“RQFII”) scheme and / or Stock Connect programmes which may entail additional clearing and settlement, regulatory, operational, counterparty and liquidity risk.
  • For distributing share classes, some Funds may pay out dividend distributions out of capital. Where distributions are paid out of capital, this amounts to a return or withdrawal of part of your original investment or capital gains attributable to that and may result in an immediate decrease in the net asset value of shares.
  • Some Funds’ investments maybe concentrated in one region / one country / one sector / around one theme and therefore the value of the Fund may be more volatile and may be subject to concentration risk.
  • The risk exists that the quantitative techniques used by some Funds may not work and the Funds’ value may be adversely affected.
  • In addition to investment, market, liquidity, counterparty, securities lending, (reverse) repurchase agreements and foreign currency risk, some Funds are subject to risk associated with fixed income investments like credit risk, interest rate risk, convertible bonds risk, ABS risk and the risk of investments in non-investment grade or unrated securities and the risk of investments made in non-investment grade sovereign securities.
  • Some Funds can use derivatives extensively. Robeco Global Consumer Trends Equities can use derivatives for hedging and efficient portfolio management. Derivatives exposure may involve higher counterparty, liquidity and valuation risks. In adverse situations, the Funds may suffer significant losses (even a total loss of the Funds’ assets) from its derivative usage.
  • Robeco European High Yield Bonds is subject to Eurozone risk.
  • Investors may suffer substantial losses of their investments in the Funds. Investor should not invest in the Funds solely based on the information provided in this document and should read the offering documents (including potential risks involved) for details.

3. Local legal and sales restrictions
The Website is not directed at any person in any jurisdiction where (by reason of that person’s nationality, residence or otherwise) the publication or availability of the Website is prohibited. Persons in respect of whom such prohibitions apply or persons other than those specified above must not access this Website. Persons accessing the Website need to be aware that they are responsible themselves for the compliance with all local rules and regulations. By accessing this Website and any of its pages, you acknowledge your agreement with understanding of the following terms of use and legal information. If you do not agree to the terms and conditions below, do not access this Website or any pages thereof.

The information contained in the Website is being provided for information purposes.

Neither information nor any opinion expressed on the Website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. The information contained in the Website does not constitute investment advice or a recommendation and was prepared without regard to the specific objectives, financial situation or needs of any particular person who may receive it. An investment in a Robeco product should only be made after reading the related legal documents such as management regulations, prospectuses, most recent annual and semi-annual reports, which can be all be obtained free of charge at www.robeco.com/hk/en and at the Robeco Hong Kong office.

4. Use of the Website
The information is based on certain assumptions, information and conditions applicable at a certain time and may be subject to change at any time without notice. Robeco aims to provide accurate, complete and up-to-date information, obtained from sources of information believed to be reliable. Persons accessing the Website are responsible for their choice and use of the information.

5. Investment performance
No assurance can be given that the investment objective of any investment products will be achieved. No representation or promise as to the performance of any investment products or the return on an investment is made. The value of your investments may fluctuate. The value of the assets of Robeco investment products may also fluctuate as a result of the investment policy and/or the developments on the financial markets. Results obtained in the past are no guarantee for the future. Past performance, projection, or forecast included in this Website should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance. Fund performance figures are based on the month-end trading prices and are calculated on a total return basis with dividends reinvested. Return figures versus the benchmark show the investment management result before management and/or performance fees; the fund returns are with dividends reinvested and based on net asset values with prices and exchange rates of the valuation moment of the benchmark.
Investments involve risks. Past performance is not a guide to future performance. Potential investors should read the terms and conditions contained in the relevant offering documents and in particular the investment policies and the risk factors before any investment decision is made. Investors should ensure they fully understand the risks associated with the fund and should also consider their own investment objective and risk tolerance level. Investors are reminded that the value and income (if any) from shares of the fund may be volatile and could change substantially within a short period of time, and investors may not get back the amount they have invested in the fund. If in doubt, please seek independent financial and professional advice.

6. Third party websites
Following links to any other off-site pages or websites of third parties shall be at the own risk of the person following such link. Robeco has not reviewed any of the websites linked to or referred to by the Website and does not endorse or accept any responsibility for their content nor the products, services or other items offered through them. Robeco shall have no liability for any losses or damages arising from the use of or reliance on the information contained on websites of third parties, including, without limitation, any loss of profit or any other direct or indirect damage.

7. Limitation of liability
Robeco as well as (possible) other suppliers of information to the Website accept no responsibility for the contents of the Website or the information or recommendations contained herein, which moreover may be changed without notice.
Robeco assumes no responsibility for ensuring, and makes no warranty, that the functioning of the Website will be uninterrupted or error-free. Robeco assumes no responsibility for the consequences of e-mail messages regarding a Robeco (transaction) service, which either cannot be received or sent, are damaged, received or sent incorrectly, or not received or sent on time.
Neither will Robeco be liable for any loss or damage that may result from access to and use of the Website.

8. Intellectual property
All copyrights, patents, intellectual and other property, and licenses regarding the information on the Website are held and obtained by Robeco. These rights will not be passed to persons accessing this information.

9. Privacy
Robeco guarantees that the data of persons accessing the Website will be treated confidentially in accordance with prevailing data protection regulations. Such data will not be made available to third parties without the approval of the persons accessing the Website, unless Robeco is legally obliged to do so. Please find more details in our Privacy and Cookie Policy.

10. Applicable law
The Website shall be governed by and construed in accordance with the laws of Hong Kong. All disputes arising out of or in connection with the Website shall be submitted to the exclusive jurisdiction of the courts of Hong Kong. 

Please click “I agree” button if you have read and understood this page and agree to the Disclaimers above and the collection and use of your personal data by Robeco, for the purposes for which such data is collected and used as set out in the Privacy and Cookie Policy, including for the purpose of direct marketing of Robeco products or services. Otherwise, please click “I Disagree” to leave the website.

I Disagree