Federal Reserve Chair Jerome Powell told US lawmakers that a “strong majority” of the policymaking committee expected two more quarter-point rate hikes this year.
Meanwhile, the Bank of England raised rates by 50 basis points, adding that recent data indicated “more persistence in the inflation process.” Markets now imply the base rate will reach a peak of 6.25%, up from the current level of 5%. The Swiss National Bank also hiked rates by 25bps and Norway’s Norges Bank delivered a larger-than-expected 50bps increase.
Top central bankers in Europe and the US have been warning that inflationary pressures have been slower to abate than expected. But despite higher rates, we think inflation could remain above central bank targets for some time. To guard against the risk of fears that inflation could run out of control, we think allocations to real assets could provide some protection to portfolios.
Consider adding exposure to infrastructure, including greentech. Infrastructure-linked assets often operate on long-term contracts tied to inflation, helping investors balance their long-term spending plans with the inflation-adjusted value of their assets. In addition, they can help stabilize income generation in a multi-asset class portfolio. We see value in assets linked to digital connectivity (5G, fiber networks, and data storage) and the energy transition (renewables, storage, and transmission). Greentech companies are exposed to infrastructure spending on the energy transition, decarbonization, and energy efficiency.
Select opportunities exist in global direct real estate. Property owners typically have the flexibility to raise rents in response to rising prices. Investors may currently be underestimating real estate’s income resilience through the indexation of rental income, in our view. Fundamentals remain robust in defensive parts of the market, including logistics, US and European multifamily apartment assets, and smaller market segments (data centers, healthcare, and student housing). Second, higher real estate yields should raise its attractiveness from next year, as higher potential incomes eventually offset capital depreciation from a higher cost of funding.
Commodities can also provide some protection against inflation. Commodities have struggled so far in 2023, with higher US and Russian production keeping the global oil market in surplus, leading to a roughly 10% fall in Brent crude oil. In addition, industrial metals have come under pressure due to disappointing Chinese activity and slowing global growth. But the recent weakness provides an opportunity to add to select positions. We expect the implemented and announced production cuts by Saudi Arabia to feed through into lower oil inventories, supporting prices.
Longer term, we also believe the structural drivers for higher commodity prices remain intact. A steady rise in emerging market demand, global efforts to achieve net-zero CO2 emissions, climate change, and structural underinvestment across almost all sectors should support commodity prices over the coming years, in our view.
So, we see various options to help investors cushion the effects of a more sustained period in which inflation runs above central bank targets.
Main contributors - Solita Marcelli, Mark Haefele, Christopher Swann, Vincent Heaney, Jon Gordon
Content is a product of the Chief Investment Office (CIO).
Original report - Real assets can help mitigate inflation risks, 23 June 2023.