Putting the inflation genie back in the lamp

Inflation should ease later in 2022 but don’t count on the 10-year rate to stay below 3%, a fixed income expert suggested Thursday.

“It has been extraordinary, what has been going on in the interest rate and inflation markets over the past 12 to 18 months,” said Raman Srivastava, global chief investment officer at Great-West Lifeco Inc. “Around this time last year, the rhetoric was completely different.”

Statistics Canada reported that inflation hit 6.7% in March. The Bank of Canada raised its benchmark rate to 1% from 0.5% earlier this month, and governor Tiff Macklem said last week that he won’t “rule anything out” regarding future rate announcements.

Federal Reserve chairman Jerome Powell said a 50-basis-point hike is possible at next week’s policy announcement.

During a Canada Life webcast on Thursday, Srivastava suggested that last year central banks were basing monetary policy on temporary inflation from transitory factors, such as supply chain disruptions and spikes in demand as Covid-19 lockdowns started to ease.

The danger is that if central bankers miscalculated and “let that inflation genie emerge from the lamp, it’s hard to squish it back in,” he said.

“Fast forward to today and I think many central banks have recognized that there has been a miscalculation. Inflation has not been transitory. And now central banks find themselves behind the curve, trying to crush that genie back into the lamp,” Srivastava said.

With markets pricing in multiple interest rate hikes for 2022, the real question, he said, is where do we go from here?

He expects inflation on goods will begin to subside this year as supply chains return to normal and consumers’ pent-up demand eases.

If there’s no further uptick in wages or service inflation, central banks could successfully tame inflation, he said.

Markets have priced in a 10-year interest rate around 3% “for the foreseeable future,” Srivastava said, but he thinks that may be too low.

The market may not be accounting for other drivers of inflation, among them baby boomers who retire and start spending their savings, he said.

“To me the risk is, if you look out over the medium term, the central banks think they have declared victory on inflation, but really that 3% [10-year rate] is too low a number,” he said. “If you remember, interest rates were 6% back in the early 2000s.”