Categories
Market Volatility
The lowdown on inflation in the US and Europe
Robert Lind
Economist
Darrell Spence
Economist
KEY TAKEAWAYS
  • Inflation likely to peak in the US in mid-2022 whereas Europe could feel the full impact of higher prices during the autumn
  • A full-blown Russian energy embargo and prolonged COVID lockdowns in China are the key inflationary risks economies are facing today
  • Contrary to popular belief, inflation can boost corporate earnings while monetary tightening isn’t always bad for equity markets

Is globalisation here to stay or are we transitioning towards a more domestic-focused world?


Robert: Over the past 30 years, the level of global integration we have seen in terms of visible trade as well as capital and financial flows has been exceptional. I think that is going to be harder to sustain in this new world environment. An important impact of the COVID pandemic was how it reminded investors and companies the importance of supply chain resilience – a point that has since been reinforced by the war in Ukraine.


Many European companies used to be able to spread their supply chains globally to make the most effective use of their capital. A classic example would be how companies in Germany have been able to import relatively cheap Russian energy, process that into manufactured goods before selling it onto China. This economic model, which has been so important for Germany as well as the rest of EU, now looks increasingly untenable.


How have the European and US economies been coping in this new environment?


Robert: Europe started the year on a strong footing thanks to the reopening of economies from Omicron-related lockdowns. That gave the regional economy a big kick to growth in the early months of 2022. But the outbreak of war in Ukraine put a halt on things and doubts are appearing with regards to the pace of Europe’s economic recovery.


The war has obviously been a source of uncertainty, but we are also seeing a significant rise in commodity prices and, in particular, energy and food prices. Business and consumer sentiment have been impacted and we are probably looking at a slowdown to the European economy relative to what we anticipated before the war.


We are yet to be in a position to talk about a significant recession but there are significant risks surrounding the ongoing war in Ukraine. Key concerns would be whether European economies could absorb higher energy prices and the European Central Bank’s response to inflation risks emanating from surging commodity prices. These issues are starting to cloud the outlook for Europe on a 12 to 18-month horizon.


Darrell: The US also rebounded strongly at the start of the year from a COVID-induced recession, but that has also created a lot of issues that need to be dealt with in the next 12 to 18 months. Russia’s invasion of Ukraine only served to make the situation more difficult be it supply chain constraints or further inflationary pressure.


Even before the war occurred, markets had been pricing in a bumpy path towards a US economic recovery. Year-to-date, the S&P 500 is down 12%1 although that is short of what we would consider a true bear market (decline in excess of 15%). While that is scant consolation for many investors, we also need to be mindful that we are exiting a prolonged period of 0% interest rates and trillions of dollars’ worth of Federal Reserve (Fed) asset purchases. Everyone knew monetary policy was not going to be loose forever and volatility is only to be expected when the unwinding eventually begins.


It is like riding an aeroplane. When the plane is flying through clear skies, the process is smooth and passengers like it. But when the descending begins, the plane starts to shake and passengers begin to feel uncomfortable. To the pilots, however, it is something they have experienced a million times so they probably would not react any differently even though the ride has gotten bumpier. As asset managers, we are like the pilots of the plane and we need to stay the course even as we descend into a different economic environment.


1. Data as at 27 April 2022. Source: Bloomberg


 


Risk factors you should consider before investing:

  • This material is not intended to provide investment advice or be considered a personal recommendation.
  • The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment.
  • Past results are not a guide to future results.
  • If the currency in which you invest strengthens against the currency in which the underlying investments of the fund are made, the value of your investment will decrease. Currency hedging seeks to limit this, but there is no guarantee that hedging will be totally successful.
  • Depending on the strategy, risks may be associated with investing in fixed income, emerging markets and/or high-yield securities; emerging markets are volatile and may suffer from liquidity problems.


Robert Lind is an economist at Capital Group. He has 33 years of industry experience and has been with Capital Group for four years. He holds a bachelor's degree in philosophy, politics and economics from Oxford University. Robert is based in London.

Darrell R. Spence  is an economist at Capital Group. He has 29 years of investment industry experience, all with Capital Group. He holds a bachelor’s degree with honors in economics from Occidental College graduating cum laude, and is a member of Phi Beta Kappa and Omicron Delta Epsilon. He also holds the Chartered Financial Analyst® designation and is a member of the National Association for Business Economics. Darrell is based in Los Angeles.


Past results are not a guarantee of future results. The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment. This information is not intended to provide investment, tax or other advice, or to be a solicitation to buy or sell any securities.

Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. All information is as at the date indicated unless otherwise stated. Some information may have been obtained from third parties, and as such the reliability of that information is not guaranteed.