If you have been following the news in recent weeks, you will have noticed that inflation has become a hot topic, even in mainstream media. We have seen the inflation rate crossing the 7% level in the United States and the 5% mark in the Euro Zone and the United Kingdom.
Consumers are worried about the rising costs of everyday items and stagnant wages. Meanwhile, investors are also trying to navigate the new market environment. With inflation running hot, the era of easy money is coming to an end and investors have to brace themselves for a rollercoaster ride as some central banks might be forced to hike rates sooner than expected and/or more aggressively.
Soaring inflation and rising interest rates – what does it mean for global markets?
First of all, volatility is likely to stay at elevated levels. While this is great news for traders who are trying to capitalize on short-term opportunities, some investors could struggle to adapt after several years of a relatively smooth ride on the stock market. Higher volatility is not limited to equity markets. Forex trading, commodities, and bonds have all become more volatile recently.
What will be the impact on the individual asset classes?
Long-term investors should not be overly concerned, as stocks tend to hold up better against inflation than other asset classes. However, investors who panic easily might want to take a close look at their portfolio and ensure that they are diversified enough and/or hedge their exposure.
Certain sectors are more likely to suffer from an increase in inflation and rising rates – such as the technology sector. Tech stocks such as Google, Amazon, Alphabet and Meta have seen astonishing growth in recent years, but the end of cheap money means that the stock price of those former outperformers could disappoint in the short-term.
On the other hand, traditional companies who have been struggling to keep up with the growth seen in the tech sector, could benefit from the current market environment. These sectors include banking, insurance, energy, and consumer staples.
Commodity prices generally rise when inflation is soaring, and this is exactly what we are seeing now. The global economy has rebounded from the pandemic faster and stronger than initially expected. Demand outstripped supply and supply chain issues didn´t help either.
The Bloomberg Commodity Index (TR) returned more than 30% over the past 12 months. Oil has seen a particularly dramatic rebound. While oil prices were trading in negative territory in March 2020 after most countries entered a period of lockdowns, the WTI price has breached the $90 recently and could test the psychological $100 level soon.
Bonds are also affected by inflation. An increase of the inflation rate decreases the value of a bondholder´s coupon interest payments. Hence, bonds with a longer maturity are more impacted by rising inflation.
Bond prices have an inverse relationship to interest rate. Rising rates will result in a decline of bond prices, and vice-versa.
Investors who hold bonds in their portfolio might diversify their holdings by buying foreign bonds (e.g., an US-based investors might look at European or Asian bonds), bonds with a higher yield (although those come with a higher risk) or special products such as inflation-protected bonds (an example of this are TIPS).
As we can see, rising inflation and rising interest rates impact markets in different ways. Traders will welcome the rise in volatility, while investors might want to take another look at their portfolio to ensure they are sufficiently diversified.
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