Welcome to the era of "coflation" with world economies in transition that combines two extremes: Deflation or disinflation in developed markets and inflation in emerging markets.
In a new report, UBS AG says several developments are contributing to coflation: Developed market economies, or DM, are holding interest rates near zero, while emerging markets, or EM, are keeping conditions relatively loose to keep their currencies in check. "Effectively, they are importing loose monetary policies from DM economies," UBS said. "As such, inflation will continue to be a serious problem for EM countries until major DM countries tighten their monetary policies."
Other developments include record capital inflows to emerging economies, from their developed counterparts, and undervalued currencies in the emerging group, with tight job markets and higher wage pressures. "Thus, their domestic inflationary pressures are severe, in contrast to DM economies that are seeing deflationary pressures."
There are concerns about deflation in the United States, but UBS expects inflation to eventually win out as wage pressures from exporting countries such as China bring higher import prices to the U.S.
"In particular, the Fed has been engaging in an explicit weak-dollar agenda through its zero interest rate policy and relentless quantitative easing, not only in order to boost its exports, but also to reflate asset prices and defelate liabilities," the analysts said.
"Therefore, quantitative easing and increasing money supply could eventually reflate prices and reignite inflation. During such a transition period from deflation to inflation in DM economies, we expect EM economies to suffer persistently high inflation."
How do you make money in such an era?
"In the EM world, inflation will persistently erode the purchasing power of money that would lead to a redistribution of wealth," UBS said.
"However, the portion of the population who own physical assets will enjoy net wealth appreciation, as asset appreciation will ofset the loss of purchasing power for daily necessities. In general, in a coflationary environment, the following asset classes are potential winners in emerging markets: Real estate, equity, certain commodities, and some currencies. Meanwhile, the potential losers include deposits, fixed income, and liabilities such as loans or mortgages."