Partner Content: Eoin Murray from Federated Hermes looks at the prospects for inflation, interest rates and the transition, orderly or disorderly, to net zero.
In the world of sustainable investment, we speak of an ecosystem in which the dynamics of regulations, monetary and fiscal policies, economic cycles and fundamentals come together to influence asset returns. We piece together information about the material factors that drive thematic interests, the geopolitical risks that play on supply chains and market exposures, and the sustainable value creation capabilities of companies. Our world is governed by the emergence of common reporting standards and data architectures, where the voices of industry intersect with governmental organisations and civil society. Making sense of this all is the landscape in which we invest.
With COP26 firmly behind us, all attention has turned to the treacherous macroeconomic backdrop that currently faces us. Although product shortages are easing in the UK where they have been most acute, headline inflation rose to 5.4% in December, the highest annual rate in over 30 years. With pay settlements remaining mostly below 3%, the expectation is that UK inflation will soften over the remainder of this year, despite certain sectors experiencing strong wage growth.
Some market commentators have begun to link our necessary reduction in carbon emissions to net zero with a more inflationary outlook too. Those keen to make a positive connection see the reduced supply of fossil fuels driving inflation, alongside the effects on firms of having to cope with higher carbon prices and with higher commodities prices, which are necessary for the transition to a more sustainable world. Against that we note that increased use of renewable energy is inherently deflationary, and that a world that sees lower consumer spending will also reduce inflationary pressures.
The key to understanding how this will affect markets is to consider how central banks will respond. We can split the world into two possible rate response regimes: quantitative easing and quantitative tightening. With the former, the distribution of possible returns for risk assets is truncated on the left – the downside is largely curtailed. However, with the latter and where we are today, the reverse is true – the upside is truncated, and we should expect returns on risk assets to be bounded.
Markets now expect a swift tightening of monetary policy over the next two years. A strongly growing economy, upside inflation surprises, and a more hawkish tone have all acted as tailwinds to this view. But the really interesting question is what might happen as these effects reverse? We could in fact end up with fewer interest rate rises and less tapering of the central bank balance sheet than the market is pricing in.
22 March 2022
The Marriott Hotel, Leeds
LATIF North
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As we look forward from Glasgow, it is absolutely clear that the remainder of the decade will be critical for determining whether the world is on course to meet the climate goals of the Paris Agreement. We can envisage two scenarios represented by an orderly or a disorderly transition. The latter would see little if any emissions reduction, modest growth in renewables as a source of energy and global warming on course for around +3oC. If we choose the former path, we will see a reduction in use of coal, oil and gas, with significant investment in renewables up to >$3 trillion annually, and a sizable fall in emissions.
An emphasis will be placed on monitoring, managing and review our investments against each of these scenarios to see which path we are on. Success will require a systems view of the world, and a response that includes more regulation, further reallocation of capital, and more corporate disclosure and action.
Eoin Murray is head of Investment, international, at Federated Hermes.
Disclaimer
The value of investments and income from them may go down as well as up, and you may not get back the original amount invested. Past performance is not a reliable indicator of future results.
For professional investors only. This is a marketing communication. The views and opinions contained herein are those of Eoin Murray, Head of Investment, and may not necessarily represent views expressed or reflected in other communications, strategies or products. The information herein is believed to be reliable, but Federated Hermes does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. This material is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. This document has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient. This document is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Figures, unless otherwise indicated, are sourced from Federated Hermes. This document is not investment research and is available to any investment firm wishing to receive it. The distribution of the information contained in this document in certain jurisdictions may be restricted and, accordingly, persons into whose possession this document comes are required to make themselves aware of and to observe such restrictions.
Issued and approved by Hermes Investment Management Limited (“HIML”) which is authorised and regulated by the Financial Conduct Authority. Registered address: Sixth Floor, 150 Cheapside, London EC2V 6ET. HIML is a registered investment adviser with the United States Securities and Exchange Commission (“SEC”).
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