Contribution What are the investment implications of rising global inflation?
Certain EM central banks have begun to raise rates or signal normalization
Gabriela Santos, Global Market Strategist at J.P.Morgan Asset Management. Courtesy of J.P.Morgan Asset Management
By Gabriela Santos
After a sharp drop in 2020, global inflation is rising due to recovering energy, surging goods and normalizing services prices. This reflation signals building momentum in the global economy, a support for credit and equities, especially of cyclical regions like Europe, Japan and emerging market (EM) ex North Asia.
Most central banks will likely remain patient, but certain EM central banks have begun to raise rates or signal normalization. Short-term, these local EM bond prices have suffered, but once the normalization path is priced in, higher yields and more supported currencies present an opportunity for improving yield.
After averaging 1.6 percent in 2020 and falling to 0.9 percent in November, global headline inflation moved up to 2.7 percent in April. Three components have been driving up global prices.
First, energy: After starting 2020 at $68 a barrel, Brent crude prices collapsed to $25 in April 2020 due to the closure of global activity. Since then, they recovered to near $70 in April 2021 due to improving demand from the transportation sector as economies reopen and restrained supply from oil producers. As a result, April global energy prices popped 17 percent year-over-year.
Second, goods: After averaging only 0.5 percent over the past 20 years, core goods prices dropped a further 40 basis points (bps) last year. As improving demand has met supply bottlenecks in various goods industries in April, core goods prices surged 2.9 percent.
Third, services: Normally quite stable at a 20-year average of 2.4 percent, services prices suffered a steep deceleration of 110 bps last year as the pandemic hit services industries particularly hard. As economies have progressively reopened, services prices have started to normalize, moving up from 1.0 percent early in the year to 1.7 percent in April.
As the year progresses, demand and supply imbalances should normalize in commodities, goods and services, bringing global inflation rates back to normal. However, the reason behind this move up in prices is key: the global recovery is gaining steam, which should translate to strong earnings growth this year, especially of more cyclically oriented companies. More cyclical global equity markets stand to benefit the most, an argument for adding exposure to Europe, Japan and North Asia.
Central banks in developed markets and many emerging ones will view the move up in global inflation through this positive lens, remaining on hold this year. However, certain EM central banks (such as Russia and Brazil) have begun to raise rates due to spottier track records of anchoring inflation.
China is also prioritizing normalizing policy this year, due not to consumer price inflation but rather to financial stability concerns. While investors price in the normalization path ahead, the move up in local yield curves pressures local bond prices. But once expectations are priced in, higher local bond yields and more supported currencies provide investors an opportunity to add yield. Chinese fixed income is further ahead in this process, offering anchored yields year-to-date and a yield pick-up of 170 bps over Treasuries.
The writer is Global Market Strategist at J.P.Morgan Asset Management. The article was published in the report On the Minds of investors on J.P. Morgan Asset Management's website.