It may take up to 18 months for central banks policies to curb inflation to around two per cent on an annual basis, says Julianna Spiropoulos, partner and head of investment strategy, investment and risk at LifeWorks Inc.
“Around the world, there’s concern about persistent inflation. . . . Central banks need to get inflation down, but how they will do that quickly — and how quickly that will happen — remains an open question. Many market participants believe that getting inflation down to around the four per cent area in the next few months is doable. Getting to the long-term two per cent target may be more difficult.”
One significant barrier to the success of central bank efforts may be energy prices, she says. “There’s a lot of potential for increased volatility over the next 10 to 18 months. Energy prices are a big part of that.”
According to the latest statistics from the Organization for Economic Co-operation and Development, year-over-year energy price inflation reached 40.7 per cent in its 38 member nations in June, falling to 35.3 per cent in July. Overall inflation reached 10.3 per cent in June, easing to 10.2 per cent in the following month.
The situation is particularly acute in the Eurozone, especially in countries traditionally reliant on Russian petroleum exports. According to the latest figures from the European Statistical Office, energy inflation peaked at 40 per cent on a year-over-year basis in August, while total inflation reached 10.1 per cent.
Within fixed income portfolios, Spiropoulos says Canadian defined benefit plans didn’t face the same issues as their U.K. peers over the past month. On. Sept. 28, the Bank of England had to intervene in the U.K.’s bond market to protect DB plans with liability-driven investment strategies after long-term bond yields rose 80 basis points in four days. “The factors at play here were very U.K.-specific. From Canadian plan sponsors’ point of view, where the majority of fixed income tends to be domiciled in Canada, there’s more sensitivity to local factors.”
Indeed, LDI strategies used in the U.K. differ from those used by Canadian DB plans, so plan sponsors need to consider the risks of their specific strategies, she adds. “Outside the U.K., we may see some choppiness, with fixed income rates potentially moving up and down. But many plans’ funded ratios are better than ever. [Sponsors should] monitor volatility and their funded ratios — and consider if de-risking or, possibly, annuitization, is appropriate.”