by Kate Howitt – Portfolio Manager, Fidelity Australian Opportunities Fund
The covid-19 pandemic shocked the global economy, countered by central banks with a massive increase in fiscal and monetary stimulus. The pandemic shocked globally integrated supply chains, resulting in inflation. Somewhat surprisingly though, the pandemic hasn’t detracted from a focus on climate change but has instead given more impetus on global efforts to decarbonise.
In response to this, three endeavours are now underway: central bankers are reversing course to target their policy efforts at containing inflation; corporates are restructuring their supply chains to build in greater resiliency; and – on varying timeframes – governments and companies are formulating strategies to achieve ‘net zero’ carbon emissions.
Each endeavour is a difficult balancing act. The conflict in Ukraine has just made each of them more difficult.
Central banks were already walking a tightrope. They were already trying to figure out how to wind-back the huge stimulus of the pandemic without derailing the global economic recovery. Inflationary pressures from Ukraine and Russia make that path much, much harder to calibrate.
If central banks keep policy too loose, our expectation of inflation could become entrenched. Then, when growth eventually slows after the post-pandemic surge, we’re left with stagflation.
On the other hand, if central banks raise rates aggressively to get inflation expectations under control, they could tip the global economy into recession – which is what it usually takes to get an inflation cycle under control. And, if they raise rates a lot and shrink central bank balance sheets, the loss of liquidity could prompt a repricing of assets.
The second balancing act that has come to the fore is the deglobalisation of supply chains.
After decades of falling trade barriers, slick financial integration and easy logistics, supply chains became ever-more dispersed. But these three facilitating forces are now reversing, and the sanctions resulting from the conflict in Ukraine have shown how quickly those reversals can occur. Accountability for the design of supply chains used to be the job of the Chief Operations Officer, with a focus on efficiency; now the Chief Risk Officer wants a say, bringing a different set of priorities to bear.
If efficiency is no longer the sole focus of supply chains, then corporate costs will go up. In the absence of wage increases and raw material imposts this would be more manageable; in a period of generalised inflation there are many difficult decisions to be made between shorter term cost of supply and longer-term security of supply.
The push to decarbonise is the third difficult balancing act.
On one hand, if energy shortages in Europe require more coal and more gas, and fears over high energy prices slow down the energy transition, then the world is at risk of cumulative emissions being higher than the climate can withstand.
The recent spike in energy prices, and impact on households, shows just how tightly-balanced energy markets are. If we go too fast “turning off” oil and gas and coal, paying for everyday energy needs will crowd out spending on decarbonisation. If utility bills and filling up the petrol tank are taking a larger slice of people’s wallets, fewer people will be able to afford to put solar panels on their roof or buy electric cars.
Any further increase in energy prices that could be attributed to efforts to decarbonise, may see public support for decarbonisation falter. We saw this happen after the GFC, when people’s focus shifted from saving the planet to just getting by.
That’s three very difficult balancing acts. What’s worse, these challenges interact. Higher interest rates make new onshore facilities and new green infrastructure more expensive. And wanting to ‘buy local’ makes decarbonisation harder to afford.
There are no simple answers and the world will muddle through to the least-worst outcomes. It would all be rather grim if we didn’t have capitalism’s two superpowers of innovation and market-pricing to rely on.
