Inflation & Interest rates: It takes 2 to Tango
By InCred June 13, 2022
The year 2022 brought with it a few catalytic shifts that have compelled investors to rethink their portfolio positioning. While striking a balance between astutely managing risk and capitalising upon emerging opportunities has always been a key portfolio imperative, it has become even more important in the backdrop of the current landscape. Some of the shifts, like the geopolitical tensions in Europe, inevitably caught investors by surprise especially since they came at a time when the promise of vaccines, signs of tepid recovery, and an upward moving stock markets had pushed many investors into complacency. On the other hand, certain other developments, like increasing inflation and an imminent rise in interest rates were already being widely discussed by market participants. Nonetheless, they had a significant impact on investor portfolios and are likely to shape portfolio strategies over the coming year.
As the global economy started recovering, concerns of inflation acting as a headwind also started cropping up. Generally, inflation can stem from one of two factors. Either it is caused by supply related constraints, or it is caused by increasing demand pressure. Immediately after the onset of the pandemic, inflation started rearing its ugly head due to disruptions in global supply chains and the stunted movement of goods and services across the globe. As a result, it was widely believed that as supply chain issues get resolved, inflationary pressure should ease off.
However, inflation continued its ascent due to two primary reasons. One, the war in Ukraine pushed up global crude oil prices and two, pent up demand, in the aftermath of the pandemic, drove up prices. From a low of around 1.4% in 2020, inflation rate in the United States (US) rose to 7% in 2021 and then pushed past 8% in 2022, rising to a forty year high of 8.5%.1, Inarguably, the inflation rates have become a major cause of concern for the US economy. A similar story is playing out in other parts of the world. Germany’s April 2022 inflation was at a 41-year high of 7.40%2 and the United Kingdom’s March 2022 inflation was at a 30-year high of 7%3 while Italy’s April 2022 inflation was at a 31-year high of 6.2%4. To combat the threat from rising inflation, the US Federal Reserve recently raised interest rates by half a percentage point, the biggest hike in two decades, to a range of 0.75% to 1%.5 Several other global central banks have similarly embarked upon a cycle of raising rates.
On the domestic front
While the story in India is somewhat similar, it is likely to play out differently. Inarguably, rising inflation is a cause for concern in India as well. The inflation rate in India increased to 7.79% in April 2022,6 staying above the RBI’s 2% to 6% tolerance limit for the third month in a row. The increase in inflation rate is primarily due to increasing fuel and food prices. In response to the rising inflation, and in line with several other global central banks, the RBI recently raised its repo rate by 40 basis points to 4.4%.7 However, if you look back at India’s inflation trajectory, you will find that the current rates are still significantly far from the high inflation rates that India has witnessed in the past. In a fast-growing economy like India, where income and consumption demand are growing at a strong clip, inflation can hover in the high single digits.Correspondingly, the Indian economy, with its strong human and entrepreneurial capital, is currently wellpositioned to absorb moderate rate hikes and ensure that the growth trajectory is maintained.
Staggered and informed investing is the way
In the backdrop of an anticipated turn in the global monetary policy cycle, along with lesser liquidity and dwindling monetary policy support, the yields could shift higher. Fixed income investors could look at funds with lower duration profiles and gradually shift towards medium duration strategies to minimize interest rate and re investment risks.
On the other hand, over the long term, equities provide a significant protection from inflation and may be considered by investors looking to create robust long-term portfolios. For investors with low allocation to equity, staggered investments over next few months may be a good idea, along with a preference for funds/ PMS that have a business focus driven by domestic demand and less exposure to global commodities.
While allocations to each asset class will be dictated by the investor’s overall asset allocation strategy, one must also consider structured products and alternative investments to strike the right balance.
Source for inflation figures
Disclaimer : The information and opinions are not and should not be construed as an offer or solicitation to buy or sell -any securities or make any investments. The financial instrument discussed, and opinions expressed in this presentation/note may not be suitable for all investors, who must make their own investment decisions, based on their own investment objective,financial positions, and respective needs.The reader is solely responsible for consulting his/her/its own independent advisors as to the legal, tax, accounting and related matters concerning investments and nothing in this article or in any communication shall constitute such legal, tax or accounting advice. InCred Wealth Private Ltd. is an AMFI registered Mutual Fund Distributor. InCred Wealth Pvt Ltd also acts in the capacity of distributor of various Financial Products. Some products are offered through partners and group companies of InCred. Investments are subject to market risks, read all the scheme related documents carefully before investing. InCred Wealth does NOT provide investment advisory services in any manner or form.