The BlackRock Investment Institute (BII) has warned of the dangers of scarcity inflation and its impact on global growth.
Jean Boivin, head of the BlackRock Investment Institute said inflation is no longer transitory as supply shocks have created shortages of goods, energy and food, driving up prices.
No longer transitory, inflation is now persistent and central banks are acting to normalize policies faster.
“Scarcity inflation has raised the risk of a global growth slowdown, either via the direct impact of supply shocks or through central banks slamming the brakes on the economy,” said Boivin.
Source: BlackRock Investment Institute, with data from Haver Analytics, April 2022
Inflation drivers
Since the sudden start of economic activity after Covid-19 lockdowns, supply has struggled to keep up with burgeoning demand across sectors.
Russia’s invasion of Ukraine caused a massive supply shock, compounding inflation and raising the cost of living.
The BII said that rising energy prices today are contributing 4 percentage points more to euro area inflation than in the five years before Covid-19, as the above chart shows.
Additionally, reduced food and fertilizer exports from Russia and Ukraine have created food insecurity around the word.
Again, this compounds existing pressures as farmers have already faced higher fertilizer and diesel costs.
“Scarcity inflation is compounding the dilemma for central banks around the world,” said Boivin. “The usual playbook of jacking up rates to cool the economy doesn’t really apply in a world shaped by supply.”
Central banks are normalizing policy rates back to neutral levels that neither stimulate nor restrain the economy.
The Fed is determined to normalize very quickly, with a large projected rate increase this year and a quick reduction of its balance sheet.
The key issue, according to Boivin is whether central banks will go beyond neutral and “slam the brakes on the economy” with higher rates that dampen economic activity.
“We believe central banks will ultimately choose to live with higher inflation, rather than destroy growth and employment and expect the sum total of rate hikes to be historically low given the level of inflation,” he said.
It is likely that inflation will have peaked once the Fed gets closer to natural level of rates, by which time spending on goods should be normalizing.
Investment implications
Boivin prefer equities over credit as the inflationary environment favors stocks.
“Many developed market companies so far have been able to pass on rising costs and kept margins high,” he said.
The BII is also underweight government bonds, predicting that long-term bond yields will rise further and yield curves steepen as investors demand extra compensation for the risk of holding long-term government bonds amid high inflation and debt loads.
This could be positive for short-term bonds as market expectations for rate increases have become overly hawkish. This would be positive for equities as it represents investor preference for stocks over bonds.
