Interest Rates

Inflation rates have been quiescent for many years now, so that most investors frankly do not have experience of handling inflation in their investments. The last time we had high persistent inflation was in the 70’s and early 80’s but that’s a bit before my time as I have been investing now for more than 3 decades since the late 1980’s.

Historic inflation rate
Figure 1 Historic US Inflation Rate (Source: Macrotrends)

Yes, one hears about issues with inflation in places like Zimbabwe and Venezuela but one doesn’t expect to see inflation in the developed economies. The central banks of the developed world, with their explicit inflation fighting mandate and their reactions after the Tech Crash of the early 2000’s and then the GFC of 2008 meant that inflation has been tamed across vast swathes of the world.

Interest rates have been at historic lows and in some countries even negative. It is one of the interesting debates in the city as to what caused the lack of inflation, which has been ascribed to productivity, or the China offshoring miracle, or the price competition, or impact of technology, improvements in supply chains and suppliers, etc. etc.

But then Covid happened in 2019, which lead to a massive global demand and supply shock. With the blocking of the Suez Canal by the Ever Given in 2021, the frequent lockdowns, port issues in several countries, breaking of the supply chains, reshoring /near shoring, moving away from the just- in-time model to the just-in-case model means that the supply shock ripples are still rippling through the global economy. Covid has also had an impact on the demand side and with the improvements in vaccination, pent up demand will hopefully come roaring back. Once these two things are put together, more demand combined with supply side shocks can lead to price increases. Right now, one can start seeing the price increases coming through in oil prices, food prices, intermediates, freight and the like. The smart people out there are saying this is an intermittent scenario and once the world’s demand / supply equation stabilises, inflation and price increases will subside and everything will be back to normal.

The thing is, at this moment, we simply do not know if that is going to be the case. If yes, that would be great, but I believe that the probability that inflation comes back is now higher. To tame inflation, interest rates need to rise, however it must be remembered that there is a time lag between raising interest rates and inflation being controlled, anything between 12-18 months.

With the huge Covid impact on reduced wages and earnings, politicians and ministries will be exquisitely sensitive to potential price rises causing economic distress. Whilst people will be worried about rising interest rates as well, I think price rises will be more important. Hence, there is a higher chance that there will be interest rate hikes to forestall potential future price rises. I am not even going to talk at this moment about the impact of higher interest rates, maybe which will be for a future epistle. Inflation has always existed in the world, and it will come back in some shape or form at some point in time and bring higher interest rates along with it.

So that’s my thinking and because of this, I am rebalancing my portfolio to include more gold, more virtual assets, more focus on countries with higher productivity growth and more economic freedom. Not in one shot, of course, but slowly increasing, as more and more industrial sectors are starting to show price pressures with some spare cash tucked away down the sofa cushions so that opportunistic investments can be made.

Dr. Bhaskar Dasgupta is writing this in his personal capacity and his opinions do not reflect his current or previous employers or firms with whom he has been associated with.