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July 02, 2020 | GSAM Connect

Inflation: Is It Coming Back?

Even before the economic shock caused by the coronavirus, advanced economies for years had struggled to generate inflation (Exhibit 1). Might inflation be due for a comeback? There are reasons to at least consider the possibility. Here are just a few:

  • Fiscal and monetary stimulus programs have expanded sharply
  • The US economy was on solid footing before the coronavirus outbreak (which could translate to a pickup in inflation when the pandemic subsides)
  • Central banks are likely to commit to keeping interest rates low for longer and may even try to generate inflation through inflation targeting
  • A possible shift towards de-globalization could result in supply chain fragility

EXHIBIT 1: Advanced Economies like the United States Have Struggled To Generate Inflation

Source: GSAM, Bloomberg, Bureau of Economic Analysis as of 5/31/2020. The Personal Consumption Expenditures (PCE) and Consumer Price Index (CPI) are the most common inflation measures. “Core” PCE and CPI measures exclude food and energy, which typically add volatility to the reading.


In the short run, we believe that the recent growth shock we experienced will create a disinflationary environment. But there are a number of factors that could over time determine the inflation backdrop. For instance, the shape of the recovery (L-shaped, V-shaped, or W-shaped) and how governments, central banks, consumers and businesses react could affect inflation. Depending on the backdrop, the investment tools for addressing inflation in portfolios would vary.

In the event that a demand, or growth, shock results in sustained weakness that slows the recovery, we could see a weaker inflation backdrop.

On the other hand, a quick recovery could be accompanied by some inflation, which is generally supportive of risk assets, particularly equity sectors levered to the market cycle and real assets, such as real estate investment trusts, infrastructure (including energy infrastructure) and unregulated utilities. This is because these asset classes tend to outpace inflation over the long run, and commodities in particular have performed well given price responses to demand shocks relative to more sticky supply levels (though with a higher degree of volatility).

Still, potential inflation isn’t always the result of strong growth. Geopolitics, including a preference for bringing offshore industries onshore, and trade tensions, which tend to weigh on growth, could also cause inflation to resurface. Scenarios like these tend to drive demand into inflation-linked fixed income assets, such as Treasury inflation-protected securities—also known as TIPs—and gold.

Gold has often been viewed as a way to offset these types of risks (because it holds its value whereas currencies can depreciate). But it has not always been a great hedge for inflation. Moreover, gold offers little yield and has been a traditionally volatile asset class. And physical ownership of gold is complicated.

Treasury TIPs, which are government securities, have historically been less volatile than gold. Even so, despite being government securities and having an intermediate-to-long duration profile, we do not view TIPs as a replacement for your core fixed income allocation. Rather, we think a modest allocation may be more effective than gold to help manage unexpected changes in inflation. In our view, the primary risks with TIPs are interest rates moving higher and persistently low levels of inflation.

At the end of the day, it’s important to keep in mind that growth is a significant determining factor for inflation—and that it takes different tools to address different inflation drivers.

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