While the transitory inflation narrative was prevailing throughout most of 2021, the Fed’s decision to abandon the expressing and recently in the FOMC Minutes sounding more nervous on inflation have caught the market by surprise. The interest rate outlook is changing and more market participants are beginning to warm to our thesis from early last year that inflation will not become transitory. Or it will due to base effects but the inflation level will stabilize at a higher level than what we have observed in the previous 25 years. The key underlying driver is the green transformation that is partly driving the current energy crisis and as Javier Blas at Bloomberg recently wrote in this great article Greenflation Is Very Real and, Sorry, It’s Not Transitory, even Isabel Schnabel of the ECB is recognizing that the green transformation will cause disruptions and higher prices on energy. This will feed through to households and businesses in ways we have not seen a long time.
If we then couple the green transformation with a) renewable energy that is currently not scalable enough to meet our energy demands, and b) very low investment levels in the global energy sector over a 7-year period then we have the recipe for elevated energy prices over a sustained period of time. If the market is finally waking up to this reality then equities will have to deal with not only higher prices but potentially also lower operating margins from higher input costs such as energy, metals and even worse labour.