Inflation Could Come Back Suddenly and Powerfully — Here’s How

By: TradeSmith Research Team

Feb 10, 2020 | Investing Strategies

Ken Griffin is worried about inflation. We are, too.

The market is highly complacent in its low-inflation assumptions. Many assets are priced as if inflation will stay low for years or even decades.

If inflation roars back suddenly, it could wreak havoc in treasury bonds, high-yield debt, overbought “safe havens” like consumer staples and utilities, and multiple other places. It could even trigger a new global crisis.

We aren’t there yet, but there is a way to get there quickly — and the market isn’t seeing this. It’s little wonder Griffin is worried.

Ken Griffin’s views have weight because, with a net worth of $15.5 billion according to the Bloomberg Billionaires Index, he is one of the most successful hedge fund managers in the world.

U.S. markets are “utterly and completely unprepared” for the possibility of inflation pick-up, Griffin said, in remarks reported by Bloomberg at the Economic Club of New York.

“In the United States, there is absolutely no preparedness for an inflationary environment,” Griffin added.

Not that the rest of the world looks better. As Griffin sees it, the next global financial crisis could emanate from Europe. “The amount of focus on the unsustainable amount of sovereign debt around the world is shocking to me,” he said. “I think it rears its ugly head when Italy hits the wall. Greece wasn’t big enough to really shake the foundations of the global economy.”

Ten years ago, The Economist ran a cover that said, “Acropolis Now: Europe’s Debt Crisis Spins Out of Control.” But the crisis was contained because Greece’s debt load was small compared to the rest of Europe. Not so with Italy, whose sovereign debt burden is estimated by Fortune at $2.5 trillion — ten times the size of Greece’s.


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Markets are relaxed about inflation in part because it’s been gone for so long. By official measures, the Federal Reserve has seen inflation run below its target for most of the past decade.

At the same time, low treasury bond yields — the U.S. 30-year is hovering around 2% — are a kind of low-inflation forecast stretching years out into the future.

But there are two ways inflation could surge back quickly, and the second is uglier than the first:

  • A sustained pick-up in wage growth
  • A sudden loss of confidence in central banks

The wage growth pick-up story is a normal part of economic recovery.

In this scenario, businesses hire more aggressively as sales increase, causing wages to tick up. At the same time, consumers spend more via their newfound wage gains and add to business profits. The cycle repeats itself until prices start to rise, which shows up as inflation.

The other way for inflation to surge — the far more destructive way — is for investors and consumers to register a sudden loss of faith in central banks.

Central bankers are the ultimate stewards of paper assets, because most assets are priced in fiat currency. When central banks are seen as competent and doing a good job, paper assets are attractive to hold.

But when faith in central banks is lost, fiat currency holdings are less attractive. A loss of faith occurs when central banks lose control of inflation, or a crisis erupts that they cannot stop, or expensive stimulus measures threaten to erode the currency.

This is why inflation can surge as the result of a crisis, not just in response to wage growth. With a big enough crisis at hand — like, say, an Italian default or some other thing — the central banks flood the system with liquidity, which comes as hundreds of billions’ worth of euros, dollars, yen, renminbi, or all four.

If that liquidity flood comes with a loss of confidence, the value of paper currency starts to fall, along with all manner of assets exposed to inflationary erosion.

Then, too, while inflationary wage growth tends to happen slowly — you see it in the numbers from quarter to quarter — a loss of confidence can happen all at once depending on global events, sometimes in a matter of weeks or even days. 

One way to safeguard against a sudden return of inflation is with portfolio exposure to anti-inflation assets, like precious metals and Bitcoin, which are likely to see intrinsic value rise as fiat currency values fall. There are also companies and industries to avoid in high-inflation environments — big debt loads can become crushing as interest rates rise, for example — and other companies and industries that will see profit outlooks improve (like commodity producers with expanding margins).

TradeSmith Research Team

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