It’s coming. It might not be this year or even next. But there is little doubt the inflation bus is set to slam into major developed economies, and relatively soon from the standpoint of long-term investors. This was the message from Pimco chief executive officer and co-chief investment officer last Monday.
Speaking at a Pensions & Investment conference, Mohamed El-Erian told the audience that while near-term inflation would be modest, four major economies will face a big challenge on the inflation front within the next five years. The U.S., China, Japan and the eurozone countries are driving towards what he called a “T-junction”—an unprecedented moment at which policymakers in those countries will either have to turn right or left, with no option to keep moving along the same road.
Going right or left will mean making making economic and monetary policy decisions that will inevitably lead them in one of two directions: sustained growth or weak growth and financial instability.
Said El-Erian, “This is the first time Japan, the eurozone, the United States and China are on the way to a T-junction.” With capital markets heavily influenced by “central banks in experimentation mode” we are now moving into uncharted territory, with no tested models or historical examples to use as signposts.
The result will be higher inflation—bad news for long-term investors, especially pension funds.
For now, however, investors don’t appear to be all that worried. According to BlackRock’s quarterly report on exchange-traded products (ETP), investors can’t seem to get out of inflation-protected bonds fast enough. For a second quarter in a row, these products saw outflows on the back of tepid inflation data that did little to raise fears over price spikes. In contrast, money went flowing into short-maturity funds that aren’t as vulnerable to rising rates.
El-Erian’s warning might spark a shift into assets traditionally seen as good hedges against inflation. Commodities, for example, might get a boost over the next 12 months or so as the potential for inflation comes more clearly into view. In the meantime, as global economies head for the T-junction down the road, let’s just hope we don’t end up slamming into anything.