Planning for a scenario with an inflation surprise has come back on the table in response to the COVID-19 related historic stimulus. Keeping this in mind, it may be prudent for investors to include an allocation to real assets to increase the diversification of their portfolio so as to mitigate unexpected inflation’s potentially adverse outcomes for growth and asset values.
Investors are faced with a quandary in the COVID-19 global economy as they navigate the concurrent threats of deflation and inflation. The economic backdrop allows for arguments supporting each outcome. The deflationary scenario results from debt-financed stimulus and persistently curtailed economic activity as the world tentatively recovers from lockdown measures, yielding some of the worse economic data on record. Not to mention that inflation expectations have stubbornly sat well below the central bank targets since the 2008 financial crisis.
However, inflation cannot be ruled out given the swift rise in M2 money supply, the globally coordinated policy response and challenges to existing supply chains. Central bank balance sheets have ballooned to record levels and policy makers have already tipped their hands toward delivering additional monetary support if necessary. This, plus the more than US$10 trillion worth of negative yielding debt across the world and Federal Funds futures still pricing in the possibility of slightly negative US rates in mid-2021, has created a recipe for inflation.