What Weak Inflation Means For Your Investments

What Weak Inflation Means For Your Investments

over 3 years ago3 mins

With central banks around the world doing “whatever it takes” to support economic growth, why are there so few signs of runaway inflation – and what does it mean for your investments? A report this week from TD Securities explains all.

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What does this mean?

TD outlined half a dozen drivers of inflation – the trend of rising prices over time – and a competing set of themes pushing prices lower.

Let’s start with inflation:

1️⃣ People are buying more stuff – like bikes and cars – even as they cut down on visits to restaurants. This is shifting inflation away from the services part of the economy and towards goods.

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2️⃣ The COVID pandemic encourages manufacturers to seek suppliers closer to home that are less vulnerable to transport shutdowns – but local suppliers will probably prove move expensive, with prices feeding through to the end buyer.

3️⃣ Money supply from central banks is climbing. More money in the economy means the value of each dollar or euro will fall, at least in theory.

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4️⃣ Central banks are becoming more willing to entertain the idea of allowing inflation to run above target.

5️⃣ The current cheap oil price could lead to an inflation spike in 2021 if prices rise from this low base.

6️⃣ Central bank support is being matched with support from governments – via payments to unemployed and furloughed workers, for example. This is in contrast to the financial crisis of 2008 when central bank support was tempered by government austerity.

And now let's look at the drivers of disinflation:

1️⃣ Slack in the economy. The pandemic has forced businesses to cut jobs, and people without jobs don’t spend as much.

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2️⃣ Government debt loads are high and preclude much more spending to boost the economy.

3️⃣ The work-from-home trend may actually benefit businesses who can suddenly hire without worrying as much about the employee’s location, pulling wages lower. Why pay $400,000 for a software developer in San Francisco if you can get one in Wyoming for a fraction of the price.

4️⃣ Whenever the future is uncertain – as it certainly is at the moment – people will tend to save more so they have a financial cushion. This takes money out the economy and saps demand for products and services.

5️⃣ Central banks’ quantitative easing may be unintentionally disinflationary by keeping “zombie” companies alive that would otherwise fail. Under this theory – which is far from mainstream in economics – these companies increase supply of goods and services and hence drag prices lower.

After examining all these trends, TD has decided that weak employment is the decisive factor – meaning deflation is more likely than significant inflation. As they note, the US unemployment rate is forecast to be more than 7% at the end of this year, double where it was before the pandemic.

Why should I care?

Although inflation may sometimes seem a little academic or intangible, it’s hard to overstate its importance to investors.

Inflation is toxic to bond prices, as it erodes the value of bonds’ future coupon payments. It also grinds away at the value of any cash you have in the bank. On the flipside, physical assets like real estate or gold should do better. Stocks sit somewhere in the middle.

So, if TD is correct, bonds should benefit and gold should suffer.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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