Investors should be prepared for biggest inflation scare since 1980s: Wood

File photo of Christopher Wood, global head of equity strategy at Jefferies
Investors should be prepared for the biggest inflation scare since the 1980s, warned Christopher Wood, global head of equity strategy at Jefferies in his weekly note to investors, GREED & fear.

“For now investors should be prepared for the biggest inflation scare since the early 1980s, and wait to see how the (US) Fed reacts. In the meantime, Treasury bonds are likely to sell off more, and cyclical stocks rally more, before any such tapering scare,” Wood said.

That said, he believes that if inflation really does return on a longer term basis, it would mean that equities and bonds would become positively correlated on the downside - that is they will both go down in price together.

The return of inflation fears have been stoked again by the rise in commodity prices, especially oil, which has jumped over 90 per cent from its March 13 level of $35 a barrel (bbl.) to around $70/bbl. now. Prices of other key commodities, such as copper, are hovering at decadal high, while food prices have also been on an uptrend since the last few months.

The markets have been cognizant of the developments and have reacted accordingly. Over the past few weeks, a rise in bond yields, especially in the US, created a flutter in global equity markets on fears of a possible rise in inflation triggered by President Joe Biden's $1.9 trillion stimulus package, who signed the stimulus bill, called the American Rescue Plan, into law on Thursday. The package provides $400 billion for $1,400 direct payments to most Americans, $350 billion in aid to state and local governments, an expansion of the child tax credit and increased funding for COVID-19 vaccine distribution.

Meanwhile, analysts at Nomura, too, share Wood's view and expect inflationary pressures to tighten their grip going ahead. The pickup in recent months, they believe, has been due primarily to higher oil prices. The consensus, they believe, is still under-estimating inflation and will revise their projections higher going ahead.

“We see four key factors that are likely to push up the headline inflation rate: base effects, government policies, commodity-push and demand-pull. While inflation is likely to be more supply-side driven initially, we believe reopening is likely to add to demand-side inflation pressures as the year progresses,” wrote Sonal Varma, managing director and chief India economist at Nomura in a March 05 report co-authored with Rebecca Wang.

 
Among Asia ex-Japan countries, Korea, Thailand and Singapore have been struggling to even get to 2 per cent inflation. "However, expectations are higher in EM Asia (India, Indonesia, the Philippines) and, if they tolerate higher inflation, then medium-term risks could rise," Varma and Wang wrote.

Those at BofA Securities, however, see a silver lining for inflation in India. Barring sporadic food led inflation spikes, they believe, India's inflation trajectory is headed lower in fiscal 2021-22 (FY22) and expect it to average at 4.6 per cent down from 6.2 per cent in FY21 as fundamental factors of inflation remain weak.

“We expect the RBI to keep the operative inflation limit in their revised framework at 6 per cent combined CPI inflation. The recent RBI's currency and finance report suggests the same,” wrote Indranil Sen Gupta, India economist at BofA Securities, in a recent co-authored note with Aastha Gudwani.


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