Why Fears of Inflation Are ‘Overblown’

The return of inflation is “not to be feared,” according to the top economist and the head researcher at S&P Global.

In a report released by S&P Global Ratings on Monday, global chief economist Paul Gruenwald and global head of research Alexandra Dimitrijevic argued that fears of inflation amid the global recovery from the coronavirus pandemic are “overblown.”

The report comes as prominent investors including Oaktree Capital Management co-founder Howard Marks warn about the risks of inflation rising after more than a decade of low inflation and low interest rates. Fund managers surveyed by Bank of America earlier this month reported that inflation was the biggest risk facing investors, bumping Covid-19 from the top spot for the first time since February 2020.

But according to S&P Global, “orderly reflation” would be a positive development for the economy and credit markets.

“An orderly lift in inflation and yields driven by a solid economic rebound from the Covid-19 shock is a good outcome on both the macro side and the credit side,” Gruenwald and Dimitrijevic wrote. “This outcome will not only restore most of the losses from 2020, but it also holds the potential of ending over a decade of persistently too low inflation and extraordinarily low yields, with the attendant distortions.”

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The S&P Global researchers said the recent rise in U.S. Treasury yields — and “spillover” into corporate bond yields — is a sign of “greater confidence in a sustained economic recovery, including a normalization of both market functioning and risk pricing.”

While they warned that there may be some growing pains — such as disproportionate inflation cutting into corporate profit margins or higher debt costs hurting highly leveraged businesses in the industries most impacted by Covid-19 — Gruenwald and Dimitrijevic said reflation is a “desired outcome” following the pandemic.

“The main risk to this desired outcome is that reflation happens too quickly or in an uneven manner,” they wrote.

If this happened, they said, credit spreads could “jump” and policymakers could react in “disruptive” ways, which could hurt corporate entities with lower credit ratings, as well as some emerging market economies.

“But it’s important to make clear that volatility and disorder around a reflation path is the risk, not reflation itself,” they concluded.