Commodities inflation panic builds to crescendo

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JPM was last onto this boat but it’s making up for lost time with a new note:

Inflation hedging was a big theme in 2010. At the time, the Fed’s Quantitative Easing increased its balance sheet above $2T. Many investors thought it will inevitably lead to inflation. There was a rush to buy commodities, gold and other inflation hedges. However, the post-GFC recovery was weak, and new crises kept on emerging–the European sovereign debt crisis, EM and China crisis, global trade war, global manufacturing recession and global pandemic. As no inflation materialized over the past decade, inflation hedgers threw in the towel, and inflation-sensitive exposures were shorted as investors piled on deflationary themes (e.g., secular growth, low volatility, ESG,etc.). Driven by deflationary trends, bonds nearly doubled and the S&P500 quadrupled since 2010, while Commodity indices significantly declined. Since 2010, the Fed’s balance sheet nearly quadrupled to $7.8T, and outside of the US, central banks instituted negative interest rates. Fiscal measures ranging from infrastructure to direct payments injected trillions. For instance, just this year, the new US administration proposed $6T of new stimulus measures.

If one stretches rubber too long, it eventually snaps. With the end of pandemic this year–global growth, bond yields, and inflation are making a sharp turn. At the same time, easy monetary and fiscal policies will likely persist for a while. In addition, there are various temporary frictions related to supply chains, reopening, as well as political and business decisions that may compound inflation. On financial asset allocation, we expect the market to be late in recognizing the inflection, which we believe already happened in November last year. For over a decade, only deflationary (long duration) trades were working, and many of today’s investment managers have never experienced a rise in yields, commodities,value stocks,or inflation in any meaningful way. A significant shift of allocations towards growth, ESG and low volatility styles over the past decade (all of which have negative correlation to inflation) left most portfolios vulnerable to a potential inflation shock.

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About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.