Updated quarterly, our evolving views on the thematics shaping the markets around us
WHY IT MATTERS | Inflation is for the economy what Samuel L. Jackson is for Tarantino – he may or may not be the lead character of the narrative, but he’s always in the picture and never goes unnoticed. Inflation is vitally important because it’s directly tied to the value of money and economic growth, two things that are quite important in financial markets.
THE TAKEAWAY | Most of the developed world has been in a decreasing inflationary environment (read disinflationary) for the better part of the last four decades, ever since Apocalypse Now hit the theatres in ’79. Institutions have, thus, tried to stimulate inflation since the 1990s in order to avoid negative levels of inflation (read deflation) as it’s widely considered one of the biggest threats to economic stability. In 2020, given the unprecedented level and type of stimulus on the back of the ‘spectacular’ economic collapse we witnessed, we’ve entered a new paradigm in which the advent of inflation (and the subsequent growth of it to undesired levels) is a real possibility.
Monetary and Fiscal Stimulus | The more governments get comfortable sending citizens “free” money, the more you’ll hear about the increased likelihood of meaningful inflation. When new money is being thrown around indiscriminately, the value of it should tend to decrease (i.e. inflation should rise).
Velocity of Money | This is an economic indicator that, in simple terms, highlights how quickly money moves around the economy. The faster money moves around, the more the economy is expected to grow. Velocity of Money was already low in 2020 and has collapsed as a result of the pandemic, and, to some extent, should rebound in 2021. The extent of that rebound is likely to determine the level of inflation one should expect.
Inflation Expectations | There’s an interesting ‘reflexive’ side to inflation, as the higher the level of its future expectations, the more consumers are likely to adjust for it, driving inflation higher today. In practical terms (and oversimplifying this to the extent that it will hurt economic PhDs to their core), if you expect your Patagonia vest to cost more in six months (as a consequence of inflation), you’re more likely to buy it today. The increase in today’s consumption as a consequence of higher future inflation expectations drives current inflation higher. Said differently, your view of the future has a material impact on your actions today.
Lower US Dollar | Given its role as the global reserve currency, its relevance in global trade (more than 50% of global trade is in US Dollars) and the number of countries who are exposed to USD-denominated debt, a lower Dollar tends to ease financial conditions globally, which helps drive inflation higher.