A woman takes pictures of the container ship Ever Legacy, which is being unloaded after arriving from Taipei to the port of Los Angeles, which is the country’s busiest container port, on March 6, 2020 in Terminal Island, California.
Mario Tama | Getty Images
As global demand returns and supply bottlenecks are likely to increase shipping, food and energy prices, Bank of america believes that inflation in the new market may be on the horizon.
In a note distributed on Sunday, EEMEA Cross Asset Strategist David Hauner emphasized that while markets are pricing the highest US inflation in a decade, new market expectations are not following suit, despite being typically more inflationary than emerging markets.
A first sign that an inflation shock could be imminent in new markets, Hauner said, was the recent rise in freight rates as a global trade boom and capacity constraints among airlines cause supply bottlenecks. BofA analysts also expect oil prices to double from 2020, noting that food prices are accelerating.
“Normally, base effects should be ignored, but we expect them to create concerns in a market that is already nervous about US inflation,” Hauner said.
Freight rates for spot containers are currently at record highs, three times the level at this time last year and twice the average for the full year 2020, although major airlines like Maersk expect it to normalize in the second quarter of 2021 and beyond.
While the long-term outlook is more balanced, he suggested that upward risk remain higher than usual, and advised investors to take the opportunity to hedge.
“Another global inflation factor is declining: the supply of workers relative to non-workers is peaking, just when degreasing and lower savings are likely to increase costs as well,” Hauner said.
“In contrast, automation remains a significant counteracting disinflation factor. The balance between these forces is likely to determine the future of long-term EM inflation.”
Hawkish central banks, resilient balances
Hauner recommended buying currencies backed by Hawkian central banks or a robust balance of payments – namely the Brazilian real, Chinese yuan, Czech koruna and South Korean won – along with oil exporters, particularly the Russian ruble and Russian equities.
“Among EM countries, an environment of rising inflation and interest rates favors markets that are resilient to higher financing costs and actually benefit from rising commodities,” Hauner said.
“This includes, for example, Russia, Saudi Arabia or the United Arab Emirates (UAE). We like Russia in equities and exchange rates and Dubai in equities.”
BofA analysts stressed that currencies in countries where central banks are most likely to raise interest rates to limit this pressure are beneficial.
“In addition to the aforementioned RUB, we also like BRL, CNH and CZK for this reason as well as KRW as a representative for China. In installments, we like bearish positions in low-yielders like Hungary or Poland.”
Hauner and his team suggested that, overall, evidence tilts in favor of investors who at least add some protection against higher inflation in new markets.
“The risks seem asymmetric: at the moment, markets are showing little concern about rising price pressures. In the coming months, upward surprises are likely to make markets more nervous also about the long-term inflation history,” he said.
“Also in the long run, reflective forces appear stronger than for a long time (looser macro-politics, de-globalization and demography), although we also appreciate the argument that automation will continue to keep a lid on EM inflation despite all these factors. “
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