INVESTING IN AN INFLATIONARY WORLD

Equity returns will be dampened, but are likely to still beat cash

-  BRUCE MOMMSEN

PAUL VOLCKER, chair of the US Federal Reserve from 1979 to 1987, is most famous as the central banker who slayed the inflation dragon which had been unleashed by energy shocks (Arab oil embargo and the Iranian Revolution) and central bank policies which were excessively pro-growth, ignoring supply side inflation drivers.

Volcker's aggressive monetary tightening might have induced a recession, but it lowered US inflation sharply and ushered in a long period of muted price hikes which underpinned the equity bull market that started in the early 1980s.

Much of the world is currently experiencing another inflation spike, with both supply and demand side drivers that share some similarities with the 1970s but in many ways are also entirely unique.

A toxic mix of excess demand and insufficient supply has resulted from COVID-19-induced demand shifts, inflexible 'just-in-time' supply chains, early-pandemic corporate pessimism, unprecedented levels of monetary and fiscal stimulus, and most recently (and most importantly) a global energy shock triggered by Russia's invasion of Ukraine.

The inevitable result is rising prices. For much of the post-global financial crisis (GFC) period, the primary challenge facing global central banks was the opposite: excess global supply, and insufficient demand, leading to stubbornly low inflation and sporadic deflation scare. This bias is likely to have prompted the initial reaction to view the spike as 'transitory', something which will likely roll over into deflation as higher energy prices feed into the base.