Inflation – will it or won’t it rise? And what are the implications for share traders?
While the Reserve Bank of Australia has confidently stated it expects inflation to remain below 2 per cent for at least the next two years, doubts are beginning to emerge.
The unpredictable nature of COVID-19 and central banks and government responses to it means inflation could rise or fall at different times across global economies.
Central bankers across the world have described lifts in inflation as transitory, meaning they will be short lived.
And while rising inflation can create risks for traders, particularly when it drives consumers to purchase less goods and causes revenues and profits to fall, it’s not all bad news.
“A sustained return of inflation is a major risk for fixed-income investments like bonds, but could provide opportunities for real asset investments and would also reduce the ‘real’ value of liabilities for indebted companies and individuals,” said Matt Weller, global head of market research at City Index.
Weller said traders can use traditional inflation hedges including real assets like commodities, inflation-protected bonds and, to a lesser extent, growth stocks.
With higher inflation, comes higher interest rates. It might spell bad news for overcommitted home owners, but traders may find silver linings.
“Higher interest rates aren’t necessarily a bad thing as they generally reflect an improving economic outlook,” explained Tony Sycamore, City Index market analyst.
“However, if they rise too quickly, they can present problems for stockmarkets and growth stocks that don’t enjoy higher interest rates.
“Companies with pricing power that can pass on higher prices will do well in terms of what opportunities come from a return in inflation. Inflation-indexed bonds will do well, as will commodity prices and the stocks of companies that mine commodities.
“Finally, value stocks, including the financial sector, should outperform the broader market as higher interest rates generally allow banks to increase revenue from a) loan books through higher net interest income, b) trading revenue from the accompanying rise in volatility.”
As for the future, the post-COVID economy is largely uncertain – and economists’ predictions vary.
But some inflationary pressures are likely to be temporary, while others, such as wages in some service industries, may be permanent.
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