Inflation - is the worst behind us?

The topic inflation is on the tip of everyone's tongue. This is understandable given the sharp rise in consumer prices and the associated high inflation figures in most countries. However, we are observing a trend reversal in key drivers such as energy and food prices. The reaction of the central banks will also dampen inflationary pressure, albeit with a delay. We assume that the peak has been reached. Due to the energy crisis in Europe, the situation will develop in a comparable way with a delay of a few months.

Text from 29 June, updated on 13 September 2022

The inflation trend is currently very strongly determining price movements on the stock markets. At its meeting in early September, for example, the European Central Bank (ECB) reacted to the recent rise in inflation by raising key interest rates by 75 basis points.

In the USA, consumer prices rose by 8.1% for the month of August, which was higher than expected and highlighted the explosive nature of the issue and caused market participants to react nervously. In our assessment of inflation, we distinguish between core inflation and the individual components of energy and food.

The latest update shows a very high contribution of all three components in a historical context. Energy generally shows very high fluctuations, while food and core inflation are relatively stable. The higher-than-expected inflation rate is due to the increase in core inflation, which rose again as expected compared to the other components.

Our assessment

In our analysis of inflation trends, we focus on leading indicators. Based on these, we draw conclusions about the coming development of inflation figures and their impact on other asset classes, first and foremost interest rates.

The currently very high contribution of the energy share to the overall consumer price index reflects an annual change in the price of crude oil of +25%. The market expectation for the coming development of the crude oil price for the coming months can be read from the futures markets. The market expects a decline in the price of crude oil (red stars in the chart below), resulting in decreasing inflationary pressure in energy inflation over time.

Food prices historically have a three-month lead to the inflation trend. The price peaks are behind us according to the development trend, which also results in decreasing inflationary pressure for the food components.

Property price development plays a decisive role in core inflation. This has a lead time of 18 months to the rental price component in the consumer price index. Since the property market was still very strong until recently, we conclude that the core inflation rate will still provide inflationary pressure in the coming months. However, higher interest rates are leaving their mark on the real estate market and sentiment has turned around. The first signs of falling prices are spreading, which means that over time inflationary pressure will also lose intensity here.

Analysis of the individual components of the consumer price index shows that the peak in the rise in inflation has been reached and the worst is behind us. At present, the supply problems that caused an additional rise in inflation in the first half of the year due to the Corona-related lockdowns are also fading away.

How are the central banks behaving and what is the impact on interest rates?

Currently, we expect the central banks to continue to act aggressively. This is because medium- to long-term inflation rates are above the central bank's target of 2%. Thus, there is further potential for rising interest rates in the short term. With the coming decline in inflationary pressure by the end of the year, central banks will have new scope to fight inflation. This will ease the situation on the interest rate market and suggests an interest rate level for 10-year US government bonds between 2 and 2.5% for the coming months.

The rise in interest rates this year brings opportunities in bonds via significantly increased yields to maturity. In the environment of increased interest rates this year, our bond strategies were able to benefit from the strategic maturity cap and achieve a significant “relative outperformance” compared to the peer group (bond funds and ETF).

No more gas supplies in Europe?

The lack of Russian gas supplies has led to rising gas prices, especially for Europe. The USA and Asia are less affected by rising prices. As a consequence, inflation figures in Europe will remain high for the time being. However, the effects described can be applied analogously to Europe, resulting only in a time lag in the decline of inflation of a few months. We are optimistic that the peak prices for European gas have been passed.

Disclaimer - legal notice

This publication was produced by the Investment Office of the Colin&Cie Group. The information and opinions contained in this document are based on sources we believe to be reliable. However, we cannot guarantee the reliability, completeness or correctness of these sources. All information and quoted rates are only up-to-date at the time of this publication and are subject to change at any time without notice. The content is based on numerous assumptions made by the Colin & Cie Group. It should be noted that different assumptions can lead to materially different results. The forecasts and assessments are only current at the time this publication is prepared and can change at any time without prior notice. Past performance of an investment is not a guarantee of future results. Certain investments can experience sudden and substantial losses in value. This information and views do not constitute a solicitation, offer or recommendation to buy or sell investment instruments or to carry out any other transactions. We recommend interested investors to consult their personal advisor before making decisions on the basis of this document so that personal investment goals, financial situation, individual needs and risk profile as well as further information can be duly taken into account as part of a comprehensive consultation. The information contained in this publication is marketing material that is distributed for advertising purposes only.