The evolution of inflation over the last 40 years has been remarkable. In the 1980s the US Federal Reserve (Fed) was very much in inflation fighting mode, but by the 1990s we had entered the so-called ‘Great Moderation’, a goldilocks period where the global economy was not too hot nor too cold.


In this century, and since the global financial crisis (GFC) in particular, the world has been beset by deflationary pressures. Now the Euro area is experiencing deflation, while in the UK and Japan inflation is only barely above zero. US inflation is nearer 1%, while even in emerging markets inflation is substantially below historical levels.


Yet today there is much talk that higher inflation could be around the corner, a debate which has intensified since the Fed announced it would pursue Average Inflation Targeting (AIT) – essentially committing, in that favourite central banking phrase, to ‘do whatever it takes’ to deliver full employment even if means letting inflation rise above the official 2% target for a while. Money supply is also a factor. The rapid growth in the Federal Reserve’s M2 measure of money supply, which includes a broad set of financial assets held principally by households, is unprecedented. Theory might suggest this heralds a spike in inflation, although something similar (albeit on a smaller scale) happened during the GFC and inflation actually went in the opposite direction.


The amount of money in the economy is growing at a remarkable rate

Inflation, deflation or both

Data sourced from Bloomberg, September 2020

Are deflationary forces still preeminent?

Ariel Bezalel (Head of Strategy, Fixed Income) has been in the deflationary camp for many years, pointing to the powerful structural forces of too much debt, aging demographics, and disruption from globalisation, technology and low cost labour. Ariel’s view is that Covid-19 has accelerated some of those trends, particularly with the massive accumulation of unproductive debt this year, which is simply backstopping the corporate sector rather than doing anything truly stimulative like investing in infrastructure. For these reasons, and perhaps controversially, given all the talk of inflation recently, he sees deflationary pressures as actually having intensified this year.


Ariel is also sceptical about the impact that quantitative easing (QE) has on the real economy, since it is essentially just an asset swap that results in cash being parked at the Federal Reserve. These are funds that the commercial banks cannot touch. So he doesn’t see conventional QE as a meaningful inflation risk, although something that could change that view would be if central banks get more serious about alternative tools such as ‘helicopter money’ (making payments directly to consumers) or a more permanent shift towards debt monetization, which would have a clearer inflationary impact.

Have central bankers given up?

The views of Mark Richards (Strategist, Multi-Asset) are more in the inflationary camp than Ariel’s. Mark agrees that structural deflationary forces are in progress, but what’s changed for him is that for the first time in decades he can see a coherent narrative for why higher inflation may materialise.


Deglobalisation is a big part of that, in Mark’s view, as the impact of China entering the global labour market and global supply chain in the late 90s/early 2000s – which depressed labour’s bargaining power – is now coming to an end. A lot of money is being spent on retooling supply chains, adding costs to the system. Mark cites two differences from the post-GFC policy response: fiscal and monetary policy are working in the same direction, with austerity and the desire for balanced budgets cast aside, and the liquidity in the system is finding its way to areas of the economy with a much higher propensity to consume.


Globalisation accelerated as China joined the WTO in 2001

Inflation, Deflation or both1

Data sourced from Refinitiv, September 2020


Mark’s view is that central bankers are admitting that they don’t know how to model inflation in this environment. The guiding principle of forty years that declining unemployment leads to inflation is broken. This means interest rates will no longer be raised in advance of expected inflation, but rather once inflation is sustainably above target.


Many underestimate the importance of inflation expectations, in Mark’s view. In Japan, workers have become used to lower wages as the price of job retention. Going down a similar path in the US and Europe would be deflationary. On the other hand, during the crisis we saw stimulus payments from the US government actually increase earnings to above pre-Covid levels: that would have an inflationary impact.


There are plenty of structural hurdles in the way of inflation: it’s too soon to predict it will return in the near future, but the tectonic plates of deglobalisation and economic policy are moving in favour.

Are we asking the right questions about inflation?

Ned Naylor-Leyland, head of Gold & Silver, believes that people are not looking at deflation in the right way. He doesn’t see it as an either/or debate, saying that the global economy can have both inflation and deflation simultaneously, and in his view it does.


Ned recognises that deflation exists in the monetary sphere, as the end result of about 40 years of policy decisions that have supported states and corporates at the expense of repressing the consumer. But he argues that if you asked people on the street about their experiences with inflation, you’d struggle to find anyone who thought their cost of living was going down.


At the heart of this question is how inflation is measured. From the 1980s onwards the traditional fixed basket of goods used to measure inflation, which modelled a consistent standard of living, was supplemented by more qualitative measures and had goods substituted from it. Ned describes some of these actions as being an ‘inflation eraser’ that has been applied to the official measures, and points to the unadjusted statistics (based on 1980 methodology) that give an insight into perhaps what the true level of inflation might be for consumers.


Adjustments to official inflation measures have depressed the statistic over time

Inflation, Deflation or both2

Courtesy of

Ned argues that this dynamic, where official inflation measures have been manipulated lower, means that consumer-level of inflation has been going up in an uncontrolled fashion, at a time more recently when wages have certainly not matched that. His view is that this is one of the factors driving the rise of populism. Ultimately, Ned believes that the deflationary and inflationary forces acting on the system will persist, but that both dynamics present investment opportunities.

How has Covid-19 changed the outlook for inflation?

Ariel’s views on investing in fixed income markets have evolved somewhat this year, and he believes that Covid-19 has definitely muddied the inflation picture. Those impacts included the hoarding of food and essential supplies, which led to inflation in those sectors, while used car prices in the US are going up as more people decide to drive rather than take public transport. Ariel also points to interesting trends in the housing market, which in the US and the UK is strong at the moment, as people move out of the city and into suburbs or the countryside. This goes some way to explain why lumber prices in the US have been so strong for much of this year.


Yet Covid-19 has also brought with it some powerful deflationary forces, in Ariel’s view, including the fallout in commercial real estate. There has also been a collapse in global travel and tourism, which represents as much as 10% of global GDP and Ariel believes some of that demand will not come back, or at least will take a long time to do so.


Ariel and his team remain constructive, despite the low yields, on US and Australian government bonds, but where their view has evolved more this year is regarding credit markets. Coming into the year they were quite cautious on credit, but now central banks have revealed their hand by doing everything to backstop credit markets, although the investment focus does need to be on businesses where revenues and profits should hold up well through the cycle.

No easy answers

There are no simple or easy answers to the myriad ways in which deflation and inflation are acting upon different parts of the world economy. The overlapping, but sometimes differing, views held by Ariel, Mark and Ned reflect to some extent the conversations happening in the wider market.


What all three agree upon, however, is that regardless of how things play out there will be opportunities to make money through investment and that running actively-managed portfolios provides a strong platform for them, as fund managers, to adapt to a changing climate with the goal of delivering superior returns to investors.

Please note:

Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested. The views expressed are those of the individuals mentioned at the time of writing are not necessarily those of Jupiter as a whole and may be subject to change. This is particularly true during periods of rapidly changing market circumstances.

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