Incertidumbre 25/05/2021

In recent weeks we have read in many places about the looming inflation problem. Is it real or not, and should we be worried about it?

To understand how inflation works, I show an outline of the drivers of inflation that Asset Damodaran has just published on his blog, and their impact on financial assets, debt and value.

drivers of inflation

According with his conlusions:

1/ Inflation is back. Overall in commodities market.

2/ We don´t know whether this inflation will be permanent or transitory. Maybe in 2 years, when global supply chains have sorted out the pandemic-related problems, inflation will return to normal. It is not clear.

3/ Return to normal. If some or all of the inflation increase is permanent, and we are reverting back to more normal inflation levels (2-3%), there will be an adjustment, perhaps even painful, as interest rates rise and stock prices recalibrate.

4/ Possibility of a breakout (very hight inflation rates). If it is permanent, and we see inflation rise to levels not seen since the 1970s and 1980s (>5%), stocks and bonds will have to be repriced significantly. Not only will investors need to move money out of financial into real assets and collectibles, but companies and individuals that have chosen to borrow to capacity, based upon current low rates, will face a default risk reckoning. This possibility is low.

We may see 2 years of a high inflation rate and then return to "normal" with very low inflation rates.