Inflation's Unpredictable Grip on Global Markets

Unexpected inflation is a major concern for financial markets and central banks worldwide. According to Challenger's Chief Economist, Jonathan Kearns, Ph.D., inflation itself is not the primary issue, but rather its unexpected nature that can cause significant disruptions.

The recent inflation shock in 2022 saw US inflation peak at 9 percent, far exceeding the expected rate of 2.3 percent reported a year earlier in a Bloomberg survey. This episode highlights that even with inflation-targeting central banks, shocks can still occur and significantly impact markets.

Inflation weakens asset returns as it disrupts economic activity, particularly when unexpected or volatile. It forces costly adjustments, such as fixed tax thresholds interacting awkwardly with rapidly changing prices and values, which disproportionately affects lower-income households. Even once inflation falls, the price level remains high, and incomes can take years to catch up.

Nominal bonds are the most obvious casualty of unexpected inflation, while equities also suffer in the short term due to higher discount rates and decreased expected cash flows. Commodities and real assets like property may be seen as hedges against inflation but have an imperfect record in compensating for higher inflation.