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The Threat of Higher Interest Rates Will Wane

A lot has been said about pandemic-induced supply issues being the reason for inflation, but there is also a huge demand influence as well. Demand for durable goods ran well above trends during the pandemic, driven by government support and people being unable to spend on services like travel and entertainment. That helped fuel inflation. With government support abating, and the service-side of economies opening up, demand for durable goods is waning.

Peloton is perhaps the poster child for this development, with the company having to halt production of bikes and treadmills to deal with weaker demand and bloated inventories. Halting production to realign inventories has a negative impact on the overall economy. While Peloton is no doubt an extreme example, we think it will be a fairly widespread phenomenon in the goods side of the economy. Last week, Lululemon warned that its results will come in at the low end of expectations due to a demand and supply mismatch.

The silver lining from the expected inventory corrections is that they will likely take the edge off of inflation, as companies reduce prices to move excess inventory.

Central banks will likely still tighten monetary policy, as they were complicit in fueling inflation. They kept policy overly accommodative when the economy was strong, and there is a lot of pressure on them now to realign that policy. However, we are optimistic that this process will not be long and grueling, as we think a slowing economy will help moderate inflation considerably. 

As we progress through the year, we believe investors will come to expect slower growth, lower inflation and relatively low interest rates. That’s an attractive backdrop for the high-quality businesses that we favour.

For more thoughts on inflation, please see our post from June 2021.