Inflation influences the purchasing power of money, and hence, the real return of one’s investments, but first, we will look at how inflation influences nominal returns.
High current inflation prints tend to be negative for nominal bonds and cash in the short run, but a regression of inflation compared to subsequent annual returns shows that nominal bonds have a mildly positive correlation, while cash and inflation show a stronger positive relationship. The reason for this is that policy rates change in relation to inflation, and hence future returns on interest-bearing instruments also change as policy rates change.
Given that the SARB opted to raise the policy rate by 50bps in its May meeting, Governor Kganyago’s comments were focused on the high level of inflation, as well as the upside risks to the SARB’s inflation outlook. This will raise the expected return for nominal bonds and cash rates over the next year as the risk-free rate rises in lockstep with the policy rate.
Interestingly, the subsequent annual returns of inflation-linked bonds seem to be negatively correlated. Linkers accrue interest quarterly and hence there will not be a perfect correlation with any single inflation print.
Even some of the historically good inflation hedges are showing little sign of efficiently protecting against inflation. While different sectors within the property asset class have specific drivers of return, the majority of property returns are usually driven by inflation and economic growth. This makes property investments a valuable hedge against inflation, but we must be cognisant of the muted GDP growth expectations in SA when investing in such assets.