How did investors learn to live with inflation? & more related News Here

For a large part of the beginning of 2020, almost every discussion of the financial markets seemed to involve aviation metaphors. Inflation soared across the rich world and central bankers raised interest rates late in an effort to cool their economies. The big question was whether they would be able to accomplish this without falling into recession. Excessive monetary tightening would lead to inflation as well as productive activity out of the economy: a “hard landing”. Those who got it right would be rewarded with a “soft landing,” in which inflation was reduced but the economy escaped recession. Alas, history has shown that hard landings occur much more often than soft landings.

Anyone proposing a third scenario – “no landing”, in which both inflation and growth remain hot – can expect short cuts from central bankers. Buttonwood himself made half a dozen bristles after asking if they could allow such a thing. Moderates reminded them that their institutions were given inflation targets by their governments and that they took them very seriously. More irritable people offered a (marginally) politer version: “How stupid and/or irresponsible do you think we are?”

Fast forward to today, however, and it looks suspiciously as if the world’s most important central bank has actually opted for perpetual flight. The Federal Reserve’s preferred measure of US inflation never dropped to its 2% target, falling below 2.3% in the 12 months to April 2025. The latest reading for May was 4.1%. Prices have risen almost as fast in Australia (4%) and are still ahead of target in the UK (2.6%) and the euro zone (2.8%).

Both investors and consumers expect inflation to remain above target. In Bank of America’s most recent monthly survey of fund managers, 54% of participants expected a “no landing” for the global economy in the coming 12 months. In the University of Michigan’s latest survey of American consumers, the average respondent expected inflation to be 4.2% over the next year. Rising energy prices since February, when the US and Israel began bombing Iran, have made matters worse. But the bigger problem is that inflation has not been below 2% since the beginning of 2021. University of Michigan respondents now expect this to average more than 3% in the long run.

So what are the lessons of the last five years on investing amid high inflation? It is no surprise that the main thing is that the claims on real assets and income sources are worth paying. With the exception of China, all the world’s largest stock markets have performed well in 2021 following a surge in consumer prices. One reason for this is surprisingly fast income growth; Another, connected, part of even faster advances in artificial intelligence. However, even in their absence, shares would still represent claims on real earnings that rise with other prices, protecting their value from the erosion of inflation.

By similar logic, bonds – most of which promise only nominal payouts – have given their investors a bad half decade. The Bloomberg index of US Treasuries has lost more than 20% of its real value. Most of the hit came from the corrosive effect of inflation on fixed-dollar coupons and principal payments; The rest comes from rising yields, which pushes down existing bond prices. Should today’s bondholders fear rising inflation in the future, they will again demand even higher yields in compensation for the fear of the same double shock.

The ultimate lesson is that inflation puts at risk even those assets that outperform them over the long term. Gold, the classic debasement hedge, has lost nearly a quarter of its market value since its peak in January. Although inflation persists, investors worry that the previous frenzy for the metal – which sought to inflation-proof their portfolios – may have pushed it into a bubble. Bonds as well as stocks and commercial property prices fell on concerns about the effects of sharply higher interest rates in 2022.

A no-landing world is less stable because high inflation doesn’t just devalue currencies. This leads investors and consumers to behave more erratically, creating their own volatility. For this reason, a few years ago it was common to hear that the no-landing scenario was actually an intermediate scenario: the flight would be so bumpy that the plane would eventually have to land. Whatever you think of this argument, such discussion is over a long time ago. So, at least for now, enjoy the flight.

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