Ahead of the Federal Reserve interest rate decision, we highlight tactics investors can consider to hedge against inflation risk
Combatting the risks of inflation and deflation
- Looking at savings rates, deflation for now remains our immediate concern
- For those looking for some inflation protection, we continue to like exposure to assets such as commodities, particularly the industrial and precious metal miners
- Infrastructure remains appealing with central banks back to balance sheet expansion
- We would argue real assets provide better relative purchasing power protection than financial assets
There’s been a lot of commentary over inflation and even some speculation of hyperinflation after the size of the Fed’s actions on 15 March and actions taken by other central banks. Looking at M1 and M2 velocity of money data for the US, action taken so far doesn’t seem to have moved the dial, with it remaining in a long-term downward trend. With the world in partial-lockdown and services and retail outlets at half capacity, this may not be surprising.
Looking at savings rates, deflation for now remains our immediate concern, particularly if there is a second wave of coronavirus that leads to notable national lockdowns. Alongside phased returns to work, this could see demand and inflationary pressures not rise as strongly as some are predicting before a deflationary bust is complete.
Over the medium to longer-term we suspect there will be an increased likelihood of inflationary pressures that are more persistent than we have experienced in decades. To that end, given the size of the fiscal and monetary expansion we anticipate, we suspect central banks and governments (provided there is sufficient political will at that point in time) will get more comfortable with higher inflation in the hope it will sufficiently shrink the size of its debt obligations. This leaves us with the clear expectation central banks and politicians will make sure inflation rates remain consistently above government bond yields for years to come.
For those looking for some inflation protection, we continue to like exposure to assets such as commodities, particularly the industrial and precious metal miners. Infrastructure remains appealing with central banks back to balance sheet expansion, and the regime of easy money will continue to push yields lower. The search for yield will become exacerbated, due to lower rates and the added impact of dividend haircuts. This should see increased demand for real assets paying contractual inflation linked to income from cash flows. Cash flows from infrastructure assets tend to have contracted recession-proof policies.
We are increasingly finding opportunities in real assets. Historically, real assets tend to perform well in late-cycle environments. We believe real assets provide an effective hedge against rising inflation, support portfolio diversification and currently generate higher cash returns over investment grade income. We have therefore been building a modest allocation to what we feel are attractively valued opportunities. Cash flows from real assets tend to have some recession proofing and, with bond yields suppressed by monetary expansion, income distributions are attractive. In a deflationary environment, we would argue real assets provide better relative purchasing power protection than financial assets.
All information given including prices, yields and our opinion is correct at the time of publication. Our opinions on investments can change at any time and for our latest view please go to www.share.com. To understand how our Investment research team arrive at their views please read our Investment Research Policy.