NZ inflation risks err on the upside despite a complex, and contradictory, set of background circumstances, Harbour Asset Management leaders told a roadshow crowd last week.
Hamish Pepper, Harbour fixed income and currency strategist, said overall the prospect of inflation exceeding expectations was “higher rather than lower”.
“There is complacency in the market,” Pepper said.
But in a both-sides-of-the-story conversation with Harbour head of fixed income, Mark Brown, he took the more dovish angle on the argument.
In theoretical debate mode, Pepper said fundamental changes to central bank interest rate management policies, mixed real economic data and the likelihood of only “transitory” price rises in the near-term, suggested inflation remained under control everywhere.
If short-term price rises sparked a “feedback loop” to higher inflation, central banks would hold fire on rates, he said.
“Even if inflation got out of hand central banks have a plethora of tools to address it,” Pepper said.
As hawk for the day, however, Brown said all the elements were now in place for raging inflation followed by central bank interest rate hikes.
He said the inputs included quantitative easing (QE) “forever” policies, massive fiscal stimulus programs, pent-up post-COVID consumer demand, supply bottlenecks and loose central bank inflation targets.
Brown said the fiscal and monetary plan involved mixing all the ingredients together, “cooking at a high temperature for as long as it takes” and not opening the oven door for “at least two years”.
If ever there was an approach guaranteed to produce out-of-control inflation and spiraling interest rates “then this recipe is it”, he said.
But while the Brown-Pepper debate illustrated the plausible scenarios on both sides of the argument, in practice Harbour has tilted its fixed income portfolio in anticipation of rising inflation.
Harbour was overweight inflation-linked bonds, Brown said, as a protection “against the tail-risk of a sharp inflation rise”.
He said corporate credit also offered return opportunities if economic growth accelerated with the caveat that higher interest rates would have disproportionate effects in different market sectors.
Investors would have to carefully assess which sectors “can’t handle higher borrowing costs”, Brown said, singling out highly geared corporates, mortgage-backed securities and even emerging market governments for attention.
Andrew Bascand, Harbour chief, said surprise inflation was “quite possibly the biggest risk” facing investors today.
“The next five years is a reasonable timeframe to set expectations,” Bascand said, citing market views of a 75 per cent chance of NZ inflation rising from 1.5 per cent to 2.5 per cent over that period.