Why asset inflation could be the real danger, not higher consumer prices
- Three factors have been driving US inflation – energy prices, production bottlenecks and aggressive stimulus programmes
- But as these risks subside in the next two to three quarters, investors cannot afford to be complacent, given the dangerously high equity valuations and hot property markets
Businesses, investors and central bankers have all been warning about the risk of inflation since the global economy started to recover in early 2021. The widely cited concern has been that aggressive government spending and interest rates at zero would prompt a sharp spike in inflation, meaning consumers would have to pay more for everything from fuel to food.
The reality may be somewhat different. It may not be the cost of household items that rockets but, rather, the price of financial assets such as real estate. That scenario would pose a bigger challenge for policymakers and investors in the next two to three years.
The first is oil and energy-related prices, which were responsible for over 70 per cent of the increase. However, a stabilisation in oil prices, largely helped by Opec’s agreement to gradually restore production in the coming months, should mean that energy prices will play a smaller role in driving inflation going forward.
Overall, many of the factors driving US inflation should subside in the next two to three quarters. This is largely reflected in the Federal Reserve’s economic forecasts. However, this does not mean investors can afford to be complacent.
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In 2008, the Fed engaged in a zero-interest-rate policy and quantitative easing to stabilise the economy as a result of the global financial crisis. Consumer inflation remained below the Fed’s 2 per cent target for much of the following decade. At the same time, the US equities and debt markets both boomed.
This turbocharged growth was not simply the result of too much money chasing too few investment opportunities. US companies are excellent at generating profit growth with innovation and strong governance structures.
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Nonetheless, a low-interest-rate environment does help to justify higher equity valuations. With low-risk assets failing to generate sufficient interest or return, investors have to take more risks to achieve their objectives, which inflates asset prices across the board.
This has also led to investments in bonds or loans with higher default risks, or in securities that provided less protection to lenders.
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Another market where prices are heating up is housing. Home prices in the US rose 18 per cent in May, compared to a year ago. That was much faster than at the peak of the US housing boom in 2008.
Again, a shortage of builders is one reason for supply failing to match resurgent demand. Yet, unlike cars or restaurant meals, real estate is an asset. Therefore, given what are now very low mortgage rates, the risk is that we could see a housing price bubble.
Moreover, there is a similar trend of rising rent and property prices in other developed economies, such as Britain and Europe.
Ample liquidity from the Fed and central banks globally could also fuel asset inflation around the world. This could come in the form of higher asset prices, or investors willing to take more risks to meet their return expectations.
Central banks are currently not well equipped to address asset inflation, since their primary focus is consumer prices. Thus, investors will need to remain alert for lurking inflation risks in what is sure to be a bumpy environment.
Tai Hui is chief market strategist for the Asia-Pacific at JP Morgan Asset Management
