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Inflation cheat sheet: Key facts, figures and definitions

2021/08/19
Inflation cheat sheet: Key facts, figures and definitions

US record ‘megadrought’, a menace to food security

2021/09/08
US record ‘megadrought’, a menace to food security

Summary

The US experienced its worst recorded drought in decades this summer. At its height, the unprecedented aridity extended across more than two-thirds of the continental area of the United States, with its most severe manifestations in the Southwest, but also extending to Oregon, Washington and North Dakota.

Click the icons below for quick answers to some of the most common inflation questions.

3 factors pushing inflation up over the short term

3 factors pushing inflation up over the long term

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What’s good about inflation

Some inflation is a good thing for economies – and for equity valuations
  • A healthy economy grows at a sustainable rate, and inflation is a typical by-product of economic growth
  • A moderate amount can also be good for the stockmarket, largely because reasonably higher prices can lead to higher earnings for companies
  • We found that for the S&P 500 Index, the highest equity valuations were observed for inflation rates of between 2% and 4%. But when inflation is beyond 5% or so, we tend to see lower earnings and lower levels of consumption overall.
 

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What’s bad about inflation

Even a small amount erodes purchasing power
  • A 3% inflation rate can reduce the value of an asset by nearly 25% in just 10 years.
  • That’s why inflation has been called a “stealth threat” to portfolios.

In just 10 years, 3% inflation could shrink an asset’s value by more than 25%
Effect of 3% annual inflation rate on initial EUR 100,000 hypothetical investment
Effect of 3% annual inflation rate on initial EUR 100,000 hypothetical
investment Source: Allianz Global Investors. Hypothetical example for illustrative purposes only.

 
  • Inflation-linked bonds – such as Treasury inflation-protected securities in the US and gilts in the UK – directly benefit from rising inflation expectations, since they are designed to help protect investors from inflation.
  • An active fixed-income investor can seek returns regardless of the inflation environment – which is critical given the uncertain inflation outlook.
  • Equities have historically provided good returns when inflation is moderate – in part because reasonably higher prices can lead to higher earnings for companies, and investors tend to pay more for earnings growth.
  • During periods of higher inflation, commodities and gold have historically done very well.
  • Institutional investors may want to consider private-market assets to hedge against – or even benefit from – a sustained return to inflation.
  • Base effect: term sometimes used when measuring inflation. When comparing two points in time, if the inflation rate is unusually low at one end (the “base”), even a small rise can appear to be an outsized increase in the inflation rate.
  • Behind the curve: term used to describe when central banks deliberately do not raise interest rates fast enough to head off inflation.
  • Break-even inflation rate: the sum of the expected inflation rate and the inflation premium. Signifies the average inflation rate where an investor would achieve the same return from either a) receiving the fixed average inflation rate or b) receiving the actual inflation as a variable cash flow.
  • CPI (consumer price index): usually refers to headline CPI, also known as headline inflation. This is a key inflation metric for the US and UK, among other regions. Refers to the full hypothetical “basket” of goods and services vs core CPI/core inflation. Because headline inflation is volatile, it is considered not very predictive over the short term.
  • Core CPI (consumer price index), core inflation: calculated by subtracting volatile food and energy prices from headline inflation.
  • CPI-U (consumer price index for all urban consumers): measures the average change over time in the prices paid by US urban consumers for a market “basket” of consumer goods and services.
  • Deflation: when inflation falls below 0%. Disinflation: when the rate of inflation falls, but doesn’t go into negative territory.
  • Expected inflation rate: represents market participants' expectation of the average yearly rate of inflation – ie, the change of the underlying price index.
  • HICP (harmonised index of consumer prices): CPI as calculated in the European Union (EU). Types of HICP include MUICP (the monetary union index of consumer prices, covering the euro area); EICP (European index of consumer prices, for the whole EU); national HICPs (for each of the EU member states); EEACIP (European Economic Area index of consumer prices): an additional HICP index for the European Economic Area (EEA) that covers the EU, Iceland and Norway.
  • Hyperinflation: a disruptively rapid rise in inflation, generally more than 50% per month.
  • Inflation expectations: the expectations of consumers and businesses on the future rate of inflation. High inflation expectations can actually push inflation up.
  • Inflation risk premium: the compensation for unexpected inflation or deflation. It is similar to an insurance premium against unexpected moves.
  • Money supply: measures an economy’s supply of cash, liquid bank accounts, long-term deposits, etc. When the money supply outpaces economic output, inflation generally follows because there is more money chasing the same amount of goods and services.
  • Nominal: before inflation is factored in (as in nominal yield, nominal growth rate, etc).
  • Output gap: the spare capacity in the economy – the difference between actual growth and potential growth. In recent years, the global economy was operating below its full potential, so the output gap increased. This is typical during economic slowdowns or recessions. Now, the output gap is shrinking.
  • PCE: the price of goods and services consumed by all households, and by nonprofits serving households. PCE has tended to be lower than CPI.
  • Real: after inflation is factored in.
  • Reflation: when deflation stops or reverses.
  • Stagflation: a period of high inflation, slow economic growth and high unemployment.
  • Wage share: the portion of economic output that gets paid to workers in the form of compensation.
  • West Texas Intermediate crude oil (WTI): one of the standard ways to track oil prices.
  • Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Investing in the water-related resource sector may be significantly affected by events relating to international political and economic developments, water conservation, the success of exploration projects, commodity prices and tax and other government regulations. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security.

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