Investors should not be complacent with another year of low inflation because inflationary indicators are just beginning to sprout. Currently, with trade disruptions and global growth moderating, many policymakers have pledged further support to boost growth and inflation. There are different drivers of inflation and investors ought to consider an allocation to commodity portfolios in order to mitigate consequences of supply shocks, which can potentially send inflation higher.
Inflation is usually driven by a demand-pull and/or cost-push effect. In the former, growing demand outweighs available supply for goods, which drives costs higher. One way that policymakers can stimulate more consumer demand and/or business spending is to either increase fiscal spending or money supply. Higher demand relative to supply may lead to more inflationary pressures. In addition, the knock-on effects of increasing money supply may potentially lead to a weakening of domestic exchange rates that can further increase the cost of foreign goods. This can be especially true for those economies that are more reliant on imports.
The cost-push effect of inflation relates to manufacturers passing on higher input costs to the end consumer. These costs can rise or fall based on changes in wages paid to employees, changes that alter the cost to manufacture the good (e.g., increasing productivity, increased regulation/tariffs, etc.), or increases in the price of raw materials driven by inventory shortages. Supply shocks can have a material impact on manufacturers' cost structures as the reduction in supplies may elevate the prices paid by consumers. Institutional investors should be mindful of the increasing potential for commodity supply shocks occurring today, and examine how an allocation to commodities in a diverse portfolio can protect against these inflation risks.