Asset Allocation Insights
Revisiting Inflation Concerns
Tim Murray, CFA, Capital Markets Strategist, Multi‑Asset Division
Key Insights
  • Inflation has increased worldwide and could prove to be higher and more persistent than expected.
  • An increased allocation to assets that help provide an effective hedge against inflation risk could be beneficial.

Overall, inflation has proven to be higher and more persistent than both the Federal Reserve and the market had expected. From March through October, inflation measures across the globe increased meaningfully (Figure 1), and future expectations have shifted dramatically.

The spike in prices has primarily been driven by supply bottlenecks and labor shortages and could be exacerbated by higher housing costs or a resurgence in the pandemic due to a new coronavirus variant. In this environment, we believe an increased allocation to assets that effectively hedge against the eroding effects of inflation may be beneficial.

Historically, commodities and stocks in commodity-related sectors—including energy and industrials—have generated strong gains during periods of high inflation. However, although commodity prices have surged this year, their upward trend has reversed sharply over the past month. Further upside may be limited given notable headwinds, including fading demand for industrial metals due to slowing industrial production in China. Also, even as U.S. oil rig counts rapidly increase, the U.S., and potentially China, plan to release strategic oil reserves, which could help to alleviate the oil demand and supply imbalance.

For investors seeking to hedge inflation risk, inflation-linked bonds such as U.S. Treasury inflation protected securities (TIPS) could offer an alternate option. TIPS are indexed to an inflation gauge to mitigate an investor’s risk from the decline in purchasing power typically caused by inflation. A review of monthly returns over a rolling 10-year period shows that, historically, short-maturity TIPS consistently have had a lower correlation to the S&P 500 Index than commodities (Figure 2), and may, therefore, provide better diversification benefits. Both commodities and commodities-related equities have also historically been much more volatile than TIPS.

As a result, our Asset Allocation Committee recently increased the allocation to TIPS, as they could, in our view, offer an attractive hedge against inflation and also help to mitigate overall portfolio risk.

Inflationary Pressures May Be More Than Transitory

(Fig. 1) Core prices continued to climb

Core prices continued to climb

As of September 2021

Line represents the market-implied inflation expectations for G‑10 countries over the next 10 years.

Sources: Bloomberg Finance L.P./Haver Analytics. Russell. See Additional Disclosures.

TIPS Could Offer More Ballast Given Lower Correlation1 to Equities

(Fig. 2) TIPS have had a lower correlation to the S&P 500 Index than commodities

TIPS have had a lower correlation to the S&P 500 Index than commodities

15 years ended November 2021, monthly data.

Source: Standard & Poor’s, Goldman Sachs, Bloomberg Finance L.P. See Additional Disclosures.

1 Correlation measures how one asset class, style or individual group may be related to another. A perfect positive correlation means that the correlation coefficient is exactly 1. This implies that as one security moves, either up or down, the other security moves in lockstep, in the same direction. A perfect negative correlation means that two assets move in opposite directions, while a zero correlation implies no relationship at all.

Additional Disclosures

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Important Information

This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.

The views contained herein are those of the authors as of December 2021 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.

This information is not intended to reflect a current or past recommendation concerning investments, investment strategies, or account types, advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Please consider your own circumstances before making an investment decision.

Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy. Actual future outcomes may differ materially from any estimates or forward-looking statements made.

Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. As interest rates rise, bond prices generally fall.  In periods of no or low inflation, other types of bonds, such as US Treasury Bonds, may perform better than Treasury Inflation Protected Securities. Diversification cannot assure a profit or protect against loss in a declining market. All charts and tables are shown for illustrative purposes only.

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