One of the major conundrums in the wake of the GFC has been why inflation has not yet risen consistently from barely above c.1% in most major economies in the wake of all the central bank “pump-priming” and Quantitative Easing (QE). The catalogue of “experts” forecasting a doom-loop of rising inflation and even hyper-inflation is a long, and by now largely discredited one.
Of course, one can be very wrong for a very long time, and then suddenly right as the narrative flips. There is just the slight intervening problem of being thoroughly ignored and discredited, although usually without suffering the fate of Cassandra, beyond reputational “death”.
However, we have been reading an interesting note by the Man Institute, entitled (The Inflation Regime Roadmap) which discusses how inflation, and good old-fashioned “financial repression” may return.
One basic problem is that inflation can have a range of causes beyond the “money-printing” that tends to obsess monetarists, as well as be curbed by off-setting factors, as has almost certainly been the case since the end of the GFC. However, as the balance shifts, this can (apparently suddenly) cause inflation to spike upwards. Reasons can range from supply/demand imbalances in an underlying economy to changes in the relative bargaining power of labour versus capital, to commodity-based “shocks” (as in the early to mid-1970s). Unfortunately, focusing on what happened on the previous occasion, or a particular path is naïve because it is invariably the unforeseen or unexpected that triggers the shift.
And different constituencies suffer disparate outcomes depending upon both scale and direction (inflation, disinflation or deflation), which makes the situation even more complicated.
However, for major fixed income investors, such as (re)insurers, a particular concern is financial repression, accompanied by negative real interest rates- i.e., where interest rates are manipulated by governments and central banks to be low in nominal terms (or even negative, as we have seen post-GFC), in an environment in which inflation starts rising. At present, central banks are more concerned with deflation and aggregate levels of demand than they are about inflation, with the pandemic seeing remarkable levels of fiscal relaxation and the creation of available money in the system to try to mitigate or prevent economic harm. As a result, nominal rates are at or close to historically low levels across the EU, US and Japan and many other jurisdictions, which makes it very hard for any (re)insurer to generate levels of Net Investment Income (NII) to act as a buffer against recent and continuing weak underwriting results.
Whether in government bonds, munis or high-grade corporates, both yields and spreads achievable on the re-investment of income and maturing portfolio assets remain low, which means that it is ever harder to mask the volatility that also flows through the P&L and Equity accounts from changes in market values.
At Awbury, we have long been aware of both the issues and the need for a solution. Therefore, we have designed and successfully implemented for the past several years a range of products which specifically address a (re)insurer’s need both to generate high quality premium flows, and to remove volatility. We believe that these products are tailor-made for today’s environment, and are happy to discuss them further with those interested in solving a demonstrable problem.
The Awbury Team