Two Fund Behemoths Say Inflation Is Here to Stay

(Bloomberg Opinion) -- As Wall Street's analysts race to outdo each other in predicting how far the Federal Reserve will go in driving up borrowing costs, two of the world's biggest asset managers have concluded that inflation won't be transitory. It looks like making money in financial markets will become more challenging for traders who've grown accustomed to central bank largesse. With the trend that's been your friend in recent years becoming less reliable, safe refuge will prove difficult to find.

Nicolai Tangen, the former hedge fund owner who now runs the world's biggest sovereign wealth fund for Norway, told Bloomberg Television last week that inflation “will remain high for a long time.” Given that backdrop, he said the $1.3 trillion fund will struggle to match its historical gains. Last year it gained 14.5%, compared with average annual returns of 6% in the past quarter of a century.

And BlackRock Inc., the world's biggest money manager with $10 trillion of assets, said in a research report that the pandemic has prompted consumers to switch to spending on goods rather than services. That shift has put pressure on manufacturing capacity and produced bottlenecks. With supply replacing demand as the key driver of higher prices, policy makers face a more difficult challenge than during past bouts of price pressure. “If central banks do go ahead and hit the brakes, they will likely learn that the damage to growth to get inflation down is too great,” BlackRock said.

The Fed looks poised to react to accelerating inflation — it reached 7% in December, its fastest pace in almost four decades — by tightening monetary conditions, raising its benchmark rate from its current 0.25% level. Prices in the futures market suggest the March increase will be the first of as many as five moves higher this year.

At that pace, the Fed funds rate would end the year at about 1.3%. That's more than half a percentage point above the average for the past decade, a period when traders and investors have become accustomed to a 0.25% borrowing cost being more prevalent than not.

Asset values that have been inflated by easy money are under threat, and the prospect of higher borrowing costs has duly sent stock markets into a tizzy. The global value of equity markets has declined by about 5% so far this year; the S&P 500 index of U.S. stocks has posted its worst start to the year in more than a decade.

The inflationary backdrop means bonds don't offer a haven. A traditional all-weather portfolio of 60% stocks and 40% bonds would have lost more than 4% last month with both asset classes slipping, according to a Bloomberg index designed to replicate that strategy.

Inflation isn't confined to the U.S. The Bank of England is poised to raise interest rates Thursday, its second consecutive increase, with consumer prices rising at their fastest pace in a decade at 5.4%. The European Central Bank is also coming under pressure to reduce its stimulus programs, with euro zone inflation unexpectedly quickening to a record 5.1% last month.

Stocks suffered the last time the Fed tightened policy. In 2018, a year when the Fed funds rate rose by a percentage point and peaked at 2.5%, the S&P 500 posted its worst full year since the global financial crisis a decade earlier, losing more than 4% on a total return basis including reinvested dividends.

The smart money is already taking some of its chips off the table. Australia's sovereign wealth fund, which oversees more than $140 billion, said earlier this week that it's reduced its exposure to the stock market in favor of cash after posting a record annual gain of 19.1% last year. “Our view is that risk is likely to be less well-rewarded in future,” Chief Executive Officer Raphael Arndt said.

BlackRock argues that the shifting economic landscape means investors need to reevaluate how they assay asset prices. “Greater macro volatility – in both growth and inflation – implies greater market volatility and higher risk premiums on bonds and equities.” Navigating the kind of gyrations seen already this year, with the S&P 500 swinging in a 10% range from high to low, will sorely test the prowess of traders who've grown accustomed to central bankers keeping the spigots of liquidity wide open.

More from Bloomberg Opinion:

ECB's Lagarde Needs to Choose Her Words Carefully: Marcus Ashworth
Fed Knows What It Needs to Do. Now Comes the Hard Part: Bill Dudley
Be Warned — The Turbulence This Time Is Different: John Authers

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Mark Gilbert is a Bloomberg Opinion columnist covering asset management. He previously was the London bureau chief for Bloomberg News. He is also the author of "Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable."