Coronavirus News Africa

OPINION | Collapsing inflation, an equity fire: What economies could see before a Covid-19 vaccine



The world bank has expressed concern over the world economy.

  • CA number of central banks across the globe are pumping money into their economies. 
  • This has sparked fears of runaway inflation – but this will likely not be the case. 
  • At present, collapsing inflation is being observed where money supply is exploding. But elsewhere, there has been little impact, while in other cases there is reason to believe the inflationary environment is unlikely to change in the next year. 
  • Other effects include additional liquidity sparking heightened interest in equities.

Central banks around the world are
pumping money into their respective economies, sparking fears of soaring future
inflation rates, but these fears are unfounded for now.

Instead, we are
seeing inflation collapsing at present, even while money supply explodes
upwards as a result of the efforts to counteract the fallout from Coronavirus’
(Covid-19) crippling lockdowns.  

Governments and
central banks around the world have unleashed extraordinary levels of monetary
stimulus to support economies hard-hit by the global pandemic. In South
Africa, the Reserve Bank (SARB) loosened monetary policy by cutting the
repo rate from 6.25% to 3.75% and has also stepped in to buy South African
government bonds to prevent bond yields from rising too high.

These similar
massive levels of stimulus globally have raised concerns that the extreme liquidity
could result in runaway inflation down the line.

This is
unlikely.

Disconnect

In the United
States (US) and other major economies, money supply and inflation have become
largely disconnected in the decade since the 2008 global financial crisis.
Despite massive injections of fiscal and monetary stimulus in the aftermath of
that crisis, inflation in developed economies has remained benign and we have
not seen a surge in consumer prices.

Similarly, in SA
core inflation has been stable, remaining within the SARB’s 3-6% target range.
Inflation as measured by Consumer Price Index (CPI), is expected to remain
muted, falling as low as 2% in the next few months and averaging around 4% in
the next 12 months.

We do not expect
the inflationary environment to change in the next year as a result of the
exploding liquidity around the world. Instead, the additional liquidity in
markets will more likely be fuel for an equity fire.

Investors will
favour equities simply because few other asset classes are expected to deliver
healthy returns in this environment. With interest rates close to zero or even
negative in some economies, the yields on developed market bonds, for example,
are not attractive.

Bumpy ride

We therefore see
the abnormal levels of global liquidity underpinning the equity markets for the
next six to 12 months. But, given the Covid-19 crisis, it is likely to be
a bumpy ride, with highly volatile periods.

In this type of
environment, we favour high quality resilient companies. Despite this
view, now is not the time to go overweight equities, however.

Given the nature
of how the Covid-19 spreads and the possibility of a second wave of infections,
leading to further lockdowns of some sorts, don’t bet on a quick recovery in
company earnings as there may still be the threat of a relapse. In that
environment, one would want to favour those companies that are able to ride out
a storm for an extended period – those with resilient balance sheets and a
resilient business model.

A vaccine for
Covid-19 is absolutely critical to the full recovery of economies and the
health of companies. But the development of a safe and effective vaccine in the
time scale envisaged has never been done before, which calls for a cautious
approach when it comes to equities, despite the liquidity underpin.

Arno Lawrenz is Global
Investment Strategist at Ashburton Investments. Views expressed are his own. 



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