Risk Wire: Do Inflationary Concerns Warrant Hedging?

Some sources of inflationary risk are more benign than others. Given the structural headwinds that the global economy faces, a broad inflation hedging programme can be expensive and unnecessary. On the other hand, the likelihood of unexpected inflation driven by regulation or supply shocks is increasing. This points to a more targeted approach when managing inflation risk.
Continuously low interest rates in the face of very low unemployment rate justifiably raise inflationary concerns. Protecting institutional portfolios against inflation does not come cheap – sensible hedge against inflation comes with increasing volatility and adds to the risk of the portfolio. It is therefore worthwhile to consider whether at least in the typical “core” scenarios of pension funds, inflationary concerns are truly justified.
The persistent low-trending levels of inflation in the past two decades are likely to be the effect of the emergence of global value chains and automation. Although there is significant political push-back against globalisation that can in theory reverse its effect on inflation, i.e. cause domestic price increases, our estimates suggest that the disinflationary effects of automation and ageing population in the coming years more than make up for the difference. In fact, if anything, the combined effect of long-term structural trends point at ~ 90 bp lower demand-driven inflation going forward. An active inflation hedging program for demand-driven inflation is therefore likely to cost more than its potential benefit.