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That’s how it goes – everybody knows

This is the best-advertised inflation spike in economic history. Everybody knows that the bar for the upcoming inflation prints is extremely low, as it compares the current recovery levels with the ones during the breakdown a year ago.

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Key takeaways:

  • The inflation spike is in. We expect upward pressure in prices to persist until year end. So far, we cannot spot a self-fulfilling spiral that may trigger a new inflation regime.

  • Investors are advised only to tweak positions. If not fully invested, gradual steps out of cash are warranted.

During recessions, prices tend to break down as demand drops. On top of that, the current readings are boosted by recovery-related distortions, as supply chains have to heal and inventories have to be refilled. So this all points to bumper readings. For the passionate inflation-spotters, I suggest taking the producer price indices (PPIs) instead of those on the consumer side. The reason is that the consumer segment has a lot more administered prices in it (e.g. healthcare, public transport, etc.), so there the real push might look a bit softer. As for the PPIs, the expected levels are +6.5% in China and +5.8% in the US.

A careful look into the future
What nobody can possibly know is how long this phase of elevated inflation rates is going to last. The base effect will abate, of course, as prices will be compared to a normalising economy by the second half of 2021. As for the other drivers, the jury is still out. Our view is that the recovery-related distortions will roughly take until year end to go away. Companies usually restock into Q4, as they prepare for the holiday shopping season. In the meantime, a lot of the supply chain disruption should be resolved too. However, this is under scrutiny, of course, as even in the modern business world animal spirits may still be more present than rational investors would like to think. In past inflation cycles, a more pronounced boost to prices came when economic actors began hoarding inventories in anticipation of higher prices. This is when the inflation spiral became self-fulfilling. Yet we do not have any evidence of this so far, and we struggle to see this happening without another supply-side shock.

Conclusion for investors
Investors are advised only to tweak positions for now. If not fully invested, gradual steps out of cash are warranted.

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