A new inflationary regime: why the next decade could look different from the last

We explore why the risk of structurally higher inflation may be the highest it has been in decades and profile the key investment implications this presents.

The views expressed are those of the authors at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional or institutional investors only.

THERE MAY BE A REGIME CHANGE UNDERWAY as we move from a monetary policy-dominant environment last cycle to globally loose fiscal policy supported by dovish monetary policy. Many of the elements driving this transition were in place before this year, but responses to the COVID-19 pandemic may have accelerated the trend. We believe this development has increased the likelihood of the economy exiting the current deflationary regime. This evolution is globally applicable, but we will mostly focus this paper on the US, given its major role in the global financial system.

In our experience, it is very difficult to predict long-term inflation levels, as it is a complicated process with many offsetting forces that no one fully understands. Even the US Federal Reserve (Fed) recently effectively admitted they are unable to project inflation accurately, instead pledging to shift to an emphasis on average realized inflation. Forty years of disinflation appear to have chipped away at policymakers’ fear of inflation. Congress seems no longer focused on the negative consequences of deficits and central bankers are more concentrated on generating inflation and tight labor markets than limiting upside to inflation. Importantly, while the COVID-19 response is hopefully a shorter-term dynamic, the change in policy preference could be more structural. We think this change increases the risk of a policy error leading to higher inflation as governments are running a real-time fiscal and monetary policy experiment with unknown outcomes.

We therefore believe that while deflationary outcomes remain a risk, the tail risk of structurally higher inflation is the greatest it has been in decades and isn’t fully captured in current market pricing. In this paper, we outline the current policy landscape, the differences between this environment and what transpired after the global financial crisis (GFC), potential paths to higher inflation, key industry dynamics, and the investment implications of a new high-inflation regime, which could be dramatic given that the financial system has become levered to low inflation and low interest rates.

A general framework for inflation

To put our current inflation outlook in perspective, let’s first outline our framework for thinking about inflation sources and expectations. Prices are impacted by the intersection of supply and demand. Demand can move cyclically, creating periods of short-term inflation driven by factors ranging from credit cycles to fiscal policy. Historically, supply-driven inflation has been fueled by…

To read more, please click the download link below.

Recommended for you

<span>Top of Mind</span> Never assume and other tips for 2021
Multi-Asset Strategist Adam Berger stress tests the consensus views on four key issues: rising interest rates, high equity valuations, US market leadership and the impact of slower globalisation on China's growth.
February 2021
Top of Mind Never assume and other tips for 2021
,
Monthly Market Snapshot: January 2021
A monthly update on equity, fixed income, currency and commodity markets.
February 2021
Monthly Market Snapshot: January 2021
,
From globalisation to a “zero-sum” game
Globalisation has increasingly begun to backpedal amid rising populism and a renewed emphasis on global competition over cooperation. Fixed Income Portfolio Manager John Soukas and Investment Director Chris Doherty discuss the implications and the role of active management in this shifting landscape.
February 2021
From globalisation to a “zero-sum” game
,
Rewriting the recovery playbook
Multi-Asset Strategist Nick Samouilhan and Investment Directors Andrew Sharp-Paul and Matthew Bullock outline a proposed new playbook for navigating an economic recovery unlike any other.
January 2021
Rewriting the recovery playbook
,
Surviving the stress test: companies adjusting to the new landscape
The pandemic has forced companies around the world to revisit their business plans and processes. Michael Carmen, co-head of Private Investments, moderates a discussion with three CEOs about how they have been navigating this time of crisis.
January 2021
Surviving the stress test: companies adjusting to the new landscape
,
Taking the mystery out of multi-asset credit investing
Perhaps the most confounding question of all: How does one even measure “success” in such a heterogeneous investment realm? Fixed Income Investment Directors Anand Dharan and Amar Reganti lay out a robust framework for doing so.
January 2021
Taking the mystery out of multi-asset credit investing
,
Global ESG Research Update — Wellington joins Net Zero Asset Managers initiative
We explain our decision to join the Net Zero Asset Managers initiative as a founding member. We also provide an update on our ESG engagement and proxy voting activity in the quarter.
January 2021
Global ESG Research Update — Wellington joins Net Zero Asset Managers initiative
,
Global ESG Research Update — Wellington joins Net Zero Asset Managers initiative
We explain our decision to join the Net Zero Asset Managers initiative as a founding member. We also provide an update on our ESG engagement and proxy voting activity in the quarter.
January 2021
Global ESG Research Update — Wellington joins Net Zero Asset Managers initiative
,