New comments shared with PLANADVISER by Charlie Ripley, senior investment strategist for Allianz Investment Management, suggest the higher levels of inflation seen in recent months are beginning to raise some important considerations for individual and institutional investors.
Simply put, the current level of inflation is difficult for the Federal Reserve to ignore, Ripley says, and some market participants are calling into question the agency’s “transitory” view on inflation.
“We believe higher levels of inflation are forcing the Fed to bring forward its exit strategy from high levels of monetary stimulus,” Ripley says. “Looking ahead, we expect some clarity for market participants as the Delta wave of the coronavirus subsides and the Fed divulges its plan for tapering the bond purchase program.”
Ripley argues the latter element is likely to cause some turbulence among risk assets over the short run, but he and his Allianz Investment Management colleagues believe unwinding the emergency monetary stimulus measures that have been in place for the past 18 months “seems highly appropriate at this juncture.”
“The transitory message on inflation from the Fed is beginning to overstay its welcome as the rise in consumer prices hasn’t moderated much,” Ripley adds. “Imbalances of supply and demand have driven inflation well above expectations this year with most of the reopening categories in the goods sectors showing the highest increase in prices.”
As has been amply covered by both financial services publications and the broader national media, supply chain issues continue to roil the economy, hitting the automobile sector and others particularly hard. With this focus on supply chains, Ripley says, the Federal Reserve (and many investors) expected the swift increase seen in consumer prices to be brief, but the prolonged situation is starting to drive up key inflation measures, with the University of Michigan’s one-year-ahead inflation expectation rising to its highest level since 2008.
“Another factor to note: Shelter costs are starting to rise as higher rents and owner’s equivalent rent are reflected in the data,” Ripley says. “Thus, we have increased our forecast in core PCE [personal consumption expenditures] inflation to end the year in a range of 3.25% to 3.75%. However, beyond 2021, we still currently expect inflation to level off and mostly be transitory.”
Putnam Investments reaches similar conclusions in a newly published fourth quarter investment outlook white paper prepared by a panel of experts within the firm.
“We wrote almost 18 months ago that progress on impeding the virus was likely to drive macroeconomic outcomes for quite some time, and we believe that continues to be the case,” the outlook notes. “Wide disparity in vaccination rates, vaccination efficacy (as defined by the level and duration of protection provided by the various manufacturers), levels of natural protection granted by previous infection rates and current health care capacity considerations on a country-by-country basis continue.”
According to Putnam Investments, many health care policy experts have coalesced around a view that COVID-19 is likely to become globally endemic like influenza, and even with all that the world has learned about the virus and treating the disease, widespread disparity continues in how governments around the world respond to outbreaks.
“These varied responses continue to drive behavior, which in turn has impact on the flow of goods and services in what continues to be an integrated global economy,” the paper says.
Putnam’s experts are of the view that core inflation in the United States should continue to normalize into early next year. However, their confidence in that view has deteriorated over the past several weeks.
“It still appears that prices in what Federal Reserve Chair Jerome Powell has referred to as ‘reopening related’ sectors of the economy have continued to mean-revert,” the paper explains. “Used car prices are an example. This is, of course, welcome news, but we also need to be wary of the path of owners’ equivalent rent over the coming quarters. This component of core CPI [Consumer Price Index] has an outsized weight in the Fed’s preferred inflation metric. It has the potential to exhibit more volatility than we have seen in decades given what has gone on in house prices nationwide.”
The paper explains that Putnam Investments has “pressed the pause button on risk-taking” and has adopted a tactically neutral posture.
“We believe the levels of volatility and sentiment priced into markets currently do not adequately account for the quantum of uncertainty across the many dimensions we have described above,” the paper concludes. “Of course, there is no such thing as certainty, and the longer you wait for clarity, the more upside you can lose. But with a game of four-dimensional chess in front of us, and variables moving in time so rapidly, we think the cost of waiting for the ride to at least slow down a bit is low.”