The stagflation challenge What really matters to the markets is policy responses.

Asia's Tech News Daily
The stagflation challenge  What really matters to the markets is policy responses.

A man wearing a face mask walks past a student begging in Siam Square in January 2021 during the pandemic. (Photo: Varuth Hirunyatheb)

After a decade of low inflation, which prompted central banks to change their inflation targets and suggest higher ability to (temporarily) tolerate rising prices, surging inflation has arrived at the worst time for policymakers, on the back of a combination of pent-up demand and a supply shortage.

First, the economic recovery in most major economies peaked in the first half of 2021. The reopening process is continuing but peak speed has passed. The Delta variant had slowed activity in many countries and vaccination progress seems to have peaked as well.

On top of that, most fiscal stimulus programmes expired late in the third quarter of this year. With fading low-base effects, growth in most countries is expected to slow down or normalise in 2022. The combination of a growth slowdown and fast-rising inflation has begun to spook the markets as they contemplate rising stagflation risks.

Second, most governments have fast-rising public debt, resulting from massive stimulus packages to mitigate coronavirus impacts. Some governments, including Thailand, might still need to borrow more for pandemic relief, and others including the US are looking at massive spending to improve their infrastructure and competitiveness.

Meanwhile, energy prices are surging amid shortages of key fuels, especially natural gas. One quick fix for high energy prices, especially in emerging economies, is government subsidies. However, this time high public debt is likely to limit governments’ willingness and ability to deploy this tool.

Third, major central banks, including the US Federal Reserve and European Central Bank (ECB), have already sent clear signals about slowing down their asset purchase programmes, which have been another key tool, in addition to raising their policy rates, to manage liquidity and the cost of borrowing.

Concern about continued rising inflation has led to rising bond yields, especially long-term yields, which are more sensitive to inflation risks.

With central banks ready to slow their bond purchase programmes, the next question is how far government bond yields, which are the borrowing cost benchmark, might go?

Compared with the historical record yields remain low, but would they be accommodative enough to support uneven economic and business recovery, given that the pandemic is still raging?

Returning to the root causes of recent inflation, pent-up demand combined with supply disruptions in key sectors, ranging from semiconductors to coal and gas, are likely to continue for the rest of 2021. That is longer than most economists and investment strategists, including myself, had expected.


Based on the latest data for energy and labour markets, an outbreak of major stagflation (similar to what happened in the 1970s) is unlikely to take place, at least for now. Recent inflation and unemployment rates in major economies are mostly under mid-single digits, compared with double-digit rates in the 1970s.

The key question for investors is how and when policymakers will take action on supply shortage-driven inflation.

The first scenario — and probably the better-case scenario for the investment community — would be for policymakers who regulate shortage-hit products to step in by releasing reserves, or at least make verbal interventions.

For example, US Energy Secretary Jennifer Granholm recently mentioned the option of releasing supplies from the country’s strategic petroleum reserve was on the table. In response to surging gas prices in Europe, Russian President Vladimir Putin eased prices by offering to help stabilise the situation (with conditions linked to the controversial Nordstream 2 natural gas pipeline).

While actual implementation remains uncertain and is likely to take time, these verbal interventions at least calmed market nerves and gave investors more time to digest the situation.

The second scenario — less preferred by investors — would be for central banks to take action by tightening monetary policy, reining in rising inflation amid uneven and uncertain demand recovery. Thus far major central banks have sent different signals. In addition to the central banks of Norway and some emerging markets such as Russia and Brazil, the Bank of England seems to be most alert to fast-rising inflation.

Fed chairman Jerome Powell recently mentioned in his view that persistently high inflation in the coming years was unlikely, but supply bottlenecks could take longer than expected in driving inflation rates in the US. The ECB seems to have distanced itself from the Bank of England, a lesson learned from 2011 when the ECB raised its policy rate in April and July in response to rising inflation amid the euro-zone debt crisis, then cut its rate in November and December the same year.


The third scenario — and the base case in my view — is a combination of the first two. Central banks adopt a wait-and-see approach and the supply shock is slowly addressed by policymakers. In its most recent “World Economic Outlook” report, the IMF said central banks should generally ignore higher prices resulting from energy price shocks or temporary difficulties in bringing products to markets.

However, the IMF said they should act if higher prices spread out and turn into wage- and broad-based inflation and/or prominent rising inflation expectations.

Markets would adopt the same wait-and-see strategy, but at a time of rising bond yields, albeit from very low levels, growth stocks are likely to be under pressure.

In our view, this wait-and-see period could provide an opportunity to accumulate more quality growth stocks. However, having value stocks in your portfolio as a hedge against a long-lasting, high-inflation period is also a good idea in my view.

Kampon Adireksombat, PhD, is first senior vice-president of SCB Chief Investment Officer.

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