Inflation continues to dominate the debate over the medium-term market trajectory. We take a deeper dive on the issues facing Australian investors.
The drivers are real
Many economies have seen negative shocks to supply (closed businesses, lack of investment) and positive shocks to demand (high savings, better labour markets, improving confidence, fewer restrictions). Commodity prices are rising and the groundswell of bottom-up signals a persistency in cost push.
And all eyes are on America
In the US, there is a clear alignment between fiscal and monetary policy and both are geared to drive inflation well into targeted ranges. Our research team sees core inflation in the US remaining above 2% for the majority of our forecast horizon, boosted in 2021 by reopening effects and supply constraints, while more persistent inflationary pressures begin to percolate beneath the surface.
The macro path for Australia
A rapid labour market recovery in Australia, alongside a stronger global economic and inflationary backdrop, should see domestic price pressures emerge at a quicker pace and our research team has upgraded its unemployment, wage and inflation forecasts in response. By the end of 2022, they expect all to have consolidated at levels not seen since at least 2014, and meaningfully ahead of policymaker expectations.
While the RBA is still dovish and likely to remove monetary accommodation gradually, this inflationary profile is strong enough to see earlier action. We think broader tapering will occur later this year as bond purchases are reduced and then ceased in the middle of next year. We also see macro-prudential tools being reintroduced earlier given housing strength, likely later this year. Importantly, our forecasts are also strong enough to see RBA hikes earlier, with two pencilled in for 2023 to leave the cash rate at 0.5% by the end of the year.
Portfolio positioning
The key question for investors is how to position themselves for the expected inflation outlook. In a recent report, Morgan Stanley analysts outline three strategies to consider:
- Early Game – Establish Pricing Power
- Mid Game – Focus on Relative Value
- End Game – Hedge the Overshoot
For a copy of our full report, speak to your Morgan Stanley financial adviser or representative. Plus, more Ideas from Morgan Stanley's thought leaders.
