Higher Inflation Ahead – What Can We Do About It?

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on Feb 16, 2021
Updated: Dec 19, 2022
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Inflation refers to the change in the price of goods and services over a certain period of time. Tracked monthly and yearly, it represents a gauge to measure future central banks monetary policy decisions. 

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Many types of inflation exist. Depending on the direction of the price changes (up or down) and on their velocity, one can refer to deflation, disinflation, or hyperinflation.

There is a consensus among economists and central banks that certain inflation levels (i.e., increases in price) help economic growth, and thus inflation sits at the core of central banks’ mandates. However, while moderate inflation is desirable, excessive inflation is not.

Inflation Expectations Rise the Most in the United States

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The monetary and fiscal policy reactions around the world are bound to create inflation. The only questions that remain are how much the prices will rise and how fast?

Yesterday, the price of oil broke above $60/barrel. This is a staggering development considering that only eleven months ago, the futures contract for the price of oil settled close to -$40.

While the bounce in the price of oil back above zero is welcomed, what followed is a different story. Effectively, the crude oil price did not stop until it broke $60 – what if it rises some more?

As a rule of thumb, when the price of oil rises, inflation follows. Or, a sharp decline in the price of oil leads to disinflation (i.e., falling inflation, but positive) or even deflation (i.e., inflation falls below zero). If a central bank had to choose between deflation and higher inflation, it would always choose the latter. Therefore, the risk during the pandemic is that the central banks and governments will not do enough, rather than considering higher inflation. In other words, the mood is something like this – it is not the time to worry about inflation, and if it comes, we’ll see then.

The chart above reflects how central banks can create inflation. After March-April 2020, the QE programs and the fiscal measures have had the same effect – rising inflation expectations. If market participants believe that the prices will rise, higher inflation becomes a self-fulfilling prophecy, and it justifies the recent rise in the price of oil.

What can investors and traders do? The classic hedges against inflation should do the trick – long gold, real estate, commodities in general.

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