In our opinion it’s clear there are likely to be several quarters of deflation as a result of the supply shock instigated by the drop-off in consumer demand associated with coronavirus-related job losses and furloughing. But it’s precisely because inflationary signals are not yet fully visible that we need to be preparing ourselves now. Over the coming months, these are the key signs that we believe investors can look out for to indicate the onset of inflation:
- Talk of “inflation make-up” by central banks, an early-warning sign of governments allowing inflation to creep back into the system;
- A move from ballooning central bank balance sheets to ballooning money supply: remember, financial QE alone didn’t move the money stock – fiscal QE can;
- Increase in fiscal deficit and increased government spending plans;
- Signs of greater protectionism/less globalisation;
- Perhaps the most important signal of all: a change in the relationship between stocks and bonds. An increase in the correlation between the two asset classes – the extent to which they move together – has historically been a sign of a pick-up in inflation.
The problem as we see it for investors is this: by the time these inflationary signals pick up, it’s going to be too late to do anything about it.
