Introduction

Introduction

The global economy has recently experienced an increasing pressure of inflation, due initially to the aftermath of the COVID-19 crisis. Starting with what was deemed temporary supply chain disruptions due to the pandemic, enhanced by Russia's invasion of Ukraine, the initial, more likely transitory inflation scenario seems to have mutated into a more structural inflation scenario. Indeed, inflationary pressures – if first explained by the aforementioned  transitory effects – are exacerbated by much longer-term effects such as the energy transition, as well as workforce behavioral changes (i.e., the Great Resignation). 

How can investors monitor their portfolios for sensitivity to inflation? What can they do to hedge against the most affected factors in a likely regime of substantial medium- to long-term inflation? This report will address these questions and introduce how to build an in-depth analysis using Bloomberg’s BQuant Enterprise platform.
 

 

The Bloomberg World Inflation Index is based on the most recent CPI YOY reading for each country and its corresponding weight in global GDP on a purchasing power parity basis, as provided by the International Monetary Fund. CPI for more than 98% of the global economy is covered. The Global Inflation has been broadening since 1921, with a current peak at over 10%.

Since the 1990s, the Western world has benefited from a very low inflation regime that partly led central banks to push their interest rates to near zero (and sometimes negative, as in the case of Japan). The cost of risk decreased mechanically as well. The low inflation regime has been entertained by many factors that seem to now be reverting: 

• Globalization: A long and stable process of international opening and globalization seems to now be reverting, with a return to populist/nationalist politics around the world and an increase in tariffs and commercial tensions between main actors (China/U.S.).
• Low-cost workforce: In addition, globalization and workforce mobility have enhanced access to low-cost labor. The reversion in globalization (Nationalism/Brexit) and continued commercial tensions between China and the U.S. have reduced access to low-cost labor.    
• Robotization and labor productivity gains: At the same time, the labor productivity gains mostly provided by higher-skilled workforce and robotization have leveled off and even decreased in some areas in the Western world, leading to a relative increase in the cost of labor.

• Structural unemployment rate: For a while, a persistent non-negligible unemployment rate, as well as a historical rise in female employment rate, offered a deep pool of available low-cost workforce. This tendency is reverting in most Western countries due, in part, to declining / aging populations and historically low unemployment rates.

   

• Low energy prices: Since the Oil Shocks of the 70s, energy prices had been going down steadily. Recently, however, energy prices have increased substantially and are more volatile. This will likely continue as fossil fuels' natural reserves are decreasing. Plus, the energy transition will lead to alternative energy sources that are structurally more costly, for now.
• Low interest rates: Monetary policy has pushed reference interest rates to zero to promote growth and reduce the cost of debt. However, inflationary pressures, high government debt levels, and the relatively low scope of actions in taxation policy during a cost-of-living crisis are now leading to a sharp increase in interest rates.
• High growth: All of these factors benefited from stable, long-term economic growth, which is now jeopardized. This impacts inflation too.

All those factor reversals contribute to a shift from low to high inflation regime.