One of the fiercest debates of 2020 from an investment perspective remains whether inflation, stagflation or deflation will be one result of the pandemic and some of the policies deployed in response to it.

No-one knows the ultimate outcome – not even central bankers, who, if they did, would not be still using and tweaking policies that were called unorthodox and exceptional when they were launched over a decade ago in further efforts to generate the inflation they crave.

All investors can do is watch out for possible signs that inflation or deflation is on the way and keep an open mind.

Judging by yields of 0.38% on the US five-year Treasury bond and 0.02% on the UK five-year Gilt, bond markets take the view that deflation remains the danger. That suggests the next few years will be like the last 10 or so – namely low growth, low inflation and low interest rates.

Such an environment has a proved fertile breeding ground for long-duration assets such as technology, biotechnology and ‘growth’ stocks, as well as bonds, but harder work for shorter-duration assets such as cyclical or ‘value’ equities and commodities.

Yet not everyone is convinced. Five-year forward inflation expectations are hovering around 1.8% and if that proves right then developed market government bonds offer relatively little protection.

Inflation expectations are not currently rising but it will be interesting to see if they are influenced by commodity prices, which are ticking higher once more.

Price movements

Even a casual glance at the media will gave a flavour of the action in commodity markets. Copper trades above $7,000 a tonne and after a 60%-plus rally since spring trades at its highest mark for two-and-a-half years.

Iron ore is pushing toward $130 a tonne and its best mark for at least five years. Soybeans stand at a four-and-half-year high and corn prices are at the highest level since July 2019. Cocoa stands at a nine-month high.

The net result is that the Bloomberg Commodity index is nearing the peak of 2018 and thus bearing down on levels last seen before that in 2014.       

The question now is whether this is a trend and whether rising raw materials costs for companies and rising food costs for consumers will lead to inflation, should the former raise prices to protect profit margins and the latter demand pay rises to help them meet the higher cost of living.

In such an uncertain economic environment as the current one, few firms or consumers may be willing to chance their arm, it must be said. But in a post-vaccine world the picture could look very different, emboldening both.

It is tempting to argue that the increase in copper and iron ore prices is one indication that an economic upturn is on the way, thanks to fiscal and monetary stimulus programmes the world over and expectations that a vaccine is on the way and 2021 will be a better place all round.

The food price increases may not be quite so conclusive and could just as easily be the result of the La Niña weather pattern which is in evidence this year. This complex meteorological feature occurs relatively rarely – America’s National Oceanic and Atmospheric Administration says this is just the seventh incidence since 1970 – but it can lead to below-average rainfall in Peru and Chile, East Africa and southwestern America and bring storms and floods to Brazil, Southern Africa, Australia and Asia.

Investors have enough imponderables to face without having to think about the weather. Second-guessing such near-term patterns really would be a mug’s game especially since inflation in America accelerated during only two of the last six La Niña patterns, even if it did so five times in the UK.

Major shift

Nevertheless, it should be informative to see how the Bloomberg Commodity index fares. Having massively outperformed equities in the first decade of this millennium, commodities were huge laggards in the second.

Whether we are on the cusp of one of those once-in-a-decade shifts that has huge ramifications for asset allocation and equity and fund selection remains to be seen. But commodity prices do not, for the moment at least, share the bond market’s conviction that the next five to 10 years are going to see the same economic backcloth as the             last five to 10.

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