latamen
A Knock at the Door: The return of inflation

A Knock at the Door: The return of inflation

05-12-2019 | Yearly outlook

Since the global financial crisis, one economic variable has stayed on our mind: inflation. In the aftermath of the crisis, it was experienced firsthand how destructive deflationary forces can be. Of course, financial markets have seen this before. The lessons drawn from the Great Depression and Japan have dictated the roadmap of central bankers over the last years. Now, 11 years after the Lehman default, it might be time to look for another course.

  • Jeroen Blokland
    Jeroen
    Blokland
    Portfolio Manager

Declining inflation is not a new phenomenon; inflation has been on a downward trajectory for decades. During its decline from initially high levels, the move downwards was seen as welcome. Central banks were hailed as having policies that were effective in keeping down inflation.

Inflation targeting, or a less explicit policy focus on inflation, was enshrined in most central bank mandates. Assets that tended to be more strongly linked to inflation massively underperformed traditional assets.

This article is part of our investment outlook 2020: ‘A Tale of Two Scenarios’.
This article is part of our investment outlook 2020: ‘A Tale of Two Scenarios’.
Read more

Inflationary assets massively lagged the market

Source: Bloomberg. Calculations: Robeco. The traditional portfolio invests in the S&P 1200 global index and US treasuries 7-10 years. The equal risk inflation portfolio invests in the S&P real assets equity index, US ILBs 7-10 years, UBS commodity (CIC) index and cash.

Globalization

In the beginning no one dared to question the success of central bank policy when it came to keeping inflation in check. However, looking back now, it is hard to deny that maybe a part of the success of central banks should be attributed to large powers that were working their way in the background.

One of the major forces that brought down inflation is globalization. To us, globalization is the coalescing of several major developments, such as the rise of technology, China joining the WTO and the liberalization of cross-border financing. All these developments created a fertile ground for companies to outsource labor and to tap into new consumer markets.

As a consequence, global trade grew rapidly while inflation fell. Global developments steadily became an important driver for domestic economies. Of course, not every economy was affected in the same way and to the same extent. But even a relatively closed economy such as the US was impacted. This can be confirmed simply by looking at the share of imports in the GDP, which rose from 5% to 15% between 1970 and 2017.

Eurozone vs US inflation

Given our strong belief that globalization played a major role in inflation, why is it that the inflation numbers in the Eurozone and US differ so much? Shouldn’t the readings be more in line with one another? In practice, there is only a general consensus on how inflation should be measured. To a certain degree, this is correct, as inflation needs to reflect regional and domestic preferences. For instance, in the US, healthcare has a much higher weight than in the Eurozone.

Still, when we correct for these preferences, some odd variations remain. For instance, does it make sense for the US to include owner equivalent rents – which reflect the inflationary source of house prices – in its CPI when the Eurozone does not? If we calculated the US CPI based on the methodology used to calculate Eurozone inflation, the difference between Eurozone inflation numbers and US ones is considerably smaller than the official numbers suggest. Global drivers have indeed become an important driver for inflation.

Definition matters: US and euro area CPI indices

Source: Federal Reserve Bank of St. Louis (FRED database). Calculations: Robeco. Indices are rebased to January 2010.

A new roadmap

Over the past years, central banks have had difficulty turning deflationary forces around, fighting against forces outside of their control. We are at a turning point for globalization. The trade conflict between the US and China and of course Brexit demonstrate that globalization will no longer be a tailwind for deflation but more likely will turn into an inflationary breeze.

Central bankers will need a new roadmap and will not be unsettled by a more than welcome increase in inflation. They will likely continue their dovish policy; an ounce of prevention is worth a pound of cure. If this plays out, 2020 may well mark the turnaround in the decade-long fall in inflation. This will have a pronounced impact on financial markets and the gap between the performance of inflationary assets and traditional assets may finally start to close.

Outlook 2020: A Tale of Two Scenarios
Download the full 2020 Outlook
Subjects related to this article are:
Logo

Important information

The Robeco Capital Growth Funds have not been registered under the United States Investment Company Act of 1940, as amended, nor or the United States Securities Act of 1933, as amended. None of the shares may be offered or sold, directly or indirectly in the United States or to any U.S. Person (within the meaning of Regulation S promulgated under the Securities Act of 1933, as amended (the “Securities Act”)). Furthermore, Robeco Institutional Asset Management B.V. (Robeco) does not provide investment advisory services, or hold itself out as providing investment advisory services, in the United States or to any U.S. Person (within the meaning of Regulation S promulgated under the Securities Act).

This website is intended for use only by non-U.S. Persons outside of the United States (within the meaning of Regulation S promulgated under the Securities Act who are professional investors, or professional fiduciaries representing such non-U.S. Person investors. By clicking “I Agree” on our website disclaimer and accessing the information on this website, including any subdomain thereof, you are certifying and agreeing to the following: (i) you have read, understood and agree to this disclaimer, (ii) you have informed yourself of any applicable legal restrictions and represent that by accessing the information contained on this website, you are not in violation of, and will not be causing Robeco or any of its affiliated entities or issuers to violate, any applicable laws and, as a result, you are legally authorized to access such information on behalf of yourself and any underlying investment advisory client, (iii) you understand and acknowledge that certain information presented herein relates to securities that have not been registered under the Securities Act, and may be offered or sold only outside the United States and only to, or for the account or benefit of, non-U.S. Persons (within the meaning of Regulation S under the Securities Act), (iv) you are, or are a discretionary investment adviser representing, a non-U.S. Person (within the meaning of Regulation S under the Securities Act) located outside of the United States and (v) you are, or are a discretionary investment adviser representing, a professional non-retail investor. Access to this website has been limited so that it shall not constitute directed selling efforts (as defined in Regulation S under the Securities Act) in the United States and so that it shall not be deemed to constitute Robeco holding itself out generally to the public in the U.S. as an investment adviser. Nothing contained herein constitutes an offer to sell securities or solicitation of an offer to purchase any securities in any jurisdiction. We reserve the right to deny access to any visitor, including, but not limited to, those visitors with IP addresses residing in the United States.

This website has been carefully prepared by Robeco. The information contained in this publication is based upon sources of information believed to be reliable. Robeco is not answerable for the accuracy or completeness of the facts, opinions, expectations and results referred to therein. Whilst every care has been taken in the preparation of this website, we do not accept any responsibility for damage of any kind resulting from incorrect or incomplete information. This website is subject to change without notice. The value of the investments may fluctuate. Past performance is no guarantee of future results. If the currency in which the past performance is displayed differs from the currency of the country in which you reside, then you should be aware that due to exchange rate fluctuations the performance shown may increase or decrease if converted into your local currency. For investment professional use only. Not for use by the general public.

I Disagree