2020 was a year characterised by some of the lowest inflation figures Australia has ever seen. Together with a rising share market since 23 March, it proved a lucrative combination for investors.
In fact, from 23 March to today, the S&P/ASX 200 Index (ASX: XJO) is up roughly 47%.
But with record low interest rates, quantitative easing (QE) programs and record budget deficits around the world, many investors are starting to worry about inflation, perhaps in the not-too-distant future.
As history has repeatedly told us, you can’t put too much extra currency into the economy without it starting to lose value. You might wonder why inflation would be bad news for share investors, since many companies will be able to pass any inflationary costs straight onto consumers.
But the reason is that higher inflation normally comes hand in hand with higher interest rates. And higher interest rates are very bad news for share prices across the board.
So will we see inflation in 2021?
One commentator thinks we might. According to reporting in the Australian Financial Review (AFR) this week, Morgan Stanley’s global head of economics Chetan Ahya has just released a note outlining 5 reasons why “inflation is set to rise much more than people are expecting”.
They are as follows:
- Private sector risk appetite – Mr Ahya points out that he expects the US economy to grow by a whopping 5.9% in 2021. He also points to the recently-acquired Democratic control of the US Congress as a likely reason why we might see further fiscal stimulus.
- ‘Soft’ unemployment – Ahya reckons that most of the job losses around the world that came as a result of the pandemic will “rebound rapidly once the economy fully opens”.
- Going for growth – Ahya notes that global policymakers such as central banks like the Reserve Bank of Australia (RBA) and the US Federal Reserve intend to “run the economy red hot” in order to rapidly return to full employment as soon as possible.
- Reigning in tech and trade – Ahya tells us that the US government, in particular, is aiming to ‘reign in’ the tech sector. Amazon.com, Inc (NASDAQ: AMZN) and Facebook Inc (NASDAQ: FB) are already facing anti-trust action. Tech is a famously ‘deflationary’ industry, so turning away from this sector could result in inflationary pressure. He also notes that deflationary ‘free trade’ policies are unlikely to resume given ongoing tensions between the US and China in particular.
- Shifting targets – Ahya reckons that the new ‘average inflation’ targets that central banks are adopting will allow inflation to run higher than what investors have seen in the past before a commensurate rise in interest rates. The report points out that Morgan Stanley economists expect US inflation to hit 2% at the end of 2021 and to “overshoot” 2% by 2022.
What higher inflation would mean for global share markets
Finally, Mr Ahya points out that if inflation rises more than expected and exceeds 2.5%, “we could see a sharp swing in expectations for Fed policy, with attendant financial market volatility“.
Something to watch out for in 2021 and beyond for ASX investors!
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