Although there is significant downward momentum to inflation in the short term, the medium-term picture is less clear. If central banks cut rates too early, they risk the medium-term outlook and raise the probability that inflation remains stubbornly sticky above their targets.

These juxtaposing outlooks for inflation point to significant uncertainty ahead, underscoring the importance for industry leaders to keep a pulse on the various scenarios in the weeks and months ahead.

There are six short-term scenarios suggesting inflation may fall:

Food prices are moving lower. Global food prices have moderated from their 2022 peak levels. In March of 2023, the Food and Agriculture Organization of the United Nations noted that world food prices had declined by 20.5 per cent from the peak levels seen just one year prior, in March 2022.

The energy price spike is over. The inflationary impact of the war in Ukraine is no longer as persistent as it once was, as European gas prices have dropped to below the levels they were trading at before the war began. Receding energy prices are likely to serve as a disinflationary force in the near term.

The cost of shipping has returned to pre-pandemic levels. Now as the pandemic drifts further into the past, shipping costs have begun to decline. With global shipping rates at or above pre-pandemic levels, this sense of normalcy provides relief to global supply chains and prices of goods.

Covid-related supply chain disruptions are easing. While the normalisation of global supply chains began easing inflationary pressures at the end of 2022, this easing is likely to continue through year end as supply chains continue to loosen, putting further downward pressure on margins.

China’s reopening may accelerate the disinflationary pulse. The reopening of Chinese factories following months of strict lockdowns suggests an improving supply picture, which is likely to turbo charge disinflationary pressures.

Manufacturing price pressures are easing. The easing of global supply chain pressures is gradually feeding into the manufacturing sectors of major economies. In the US, survey data from the Institute for Supply Management suggests the majority of manufacturers are now experiencing declining input costs. In Europe, the energy crisis has delayed the impact, but survey data from the ifo Institute show fewer German companies are planning to raise prices. A similar trend is apparent across the eurozone and the UK.

However, in the longer-term, I would caution against three scenarios in which inflation may persist:

Tight labour markets could slow the fall in inflation. Data shows demand for workers remains far stronger than would normally be the case at this stage of the economic cycle, keeping upward pressure on wages.  Perhaps the most striking thing about the current labour market is the fluid rate at which people are changing job. Rather than becoming unemployed and then employed again with a gap, people are moving from employer to employer and from role to role after much shorter periods of time. This suggests the tightness in labour markets is creating competition for staff and forcing companies to poach from each other – most likely at higher wages. The importance of labour costs as a proportion of total costs, especially in the service sector, means that wage inflation is deeply inter-connected with price inflation. The staggered, infrequent (especially in Europe) and decentralised nature of wage setting means that it is likely to take several years for wages to adjust fully to the inflation that has already occurred.

The deglobalisation hurdle. Volatile global supply chains from the pandemic and the increased geopolitical tensions from the Ukraine/Russia war may trigger a deeper reassessment of production models.

A focus on decarbonisation and more sophisticated assessments of corporate carbon footprints, are likely to decrease the appeal of long-distance transportation for goods in the long-term.

Hence, the lower costs and efficiency of globalised, just-in-time supply chains may no longer suffice, as new production models may need to be brought into place. 

Brexit remains an issue. Brexit has caused a departure of many EU workers. The arrival of non-EU workers, who were granted visas under the new immigration system, prioritises skilled workers, causing a mismatch within the labour force.

This has accentuated vacancies and labour shortages in certain sectors – a trend that is positioned to continue growing.

What does this mean for investors?

If inflation proves to be structurally sticky above central bank targets in the medium term, then central banks will have to maintain rates at restrictive levels, potentially hampering growth. A period of sub trend growth may be the acceptable pay-off to keep inflation in check, but this becomes more complex if growth weakens more meaningfully.

It was easy for central bankers to deliver a hawkish message in recent months with unemployment falling and inflation rising. A deceleration in inflation may accompany softer employment markets, so central bankers may face political pressure to accelerate monetary loosening. 

Either way, one thing is clear. We must not make brash investment decisions. Inflation can trigger much uncertainty for clients. It is important to prepare for all scenarios and protect capital, rather than make hasty decisions.

“In India we have a saying, ‘There’s always room for one more.’” This insight from our Mumbai tour guide perfectly describes what we saw during our two-week research trip through Mumbai, Bangalore, Delhi, and Amritsar.

From watching five people pack into an auto-rickshaw built for two, to weaving through the unimaginable density of vehicles, motorbikes, rickshaws, CNGs, and pedestrians on the roads and markets… From witnessing the religious and cultural diversity in the mosques and temples that dot the same streets… It’s clear that it’s not accurate to describe India as merely a “country.” India is – more aptly put – a union of states, as someone in a meeting in Delhi said. How else can you describe a land uniting 17 per cent of the world’s population (1.4 billion people), more than 2,000 ethnic groups, six major religions and 121 spoken languages (22 of them official)? 

I saw this for myself at a dinner with a group of young Indian dancers in Mumbai. In a group of 15, each person was from a different state in India (there are 29 total), spoke anywhere from three to five languages, and communicated amongst themselves in English. Three-quarters were “veg” and only a quarter “non-veg” according to their cultural beliefs and in total represented three different religions.

Our guide’s saying, evoking inclusion and community, was perhaps most visible at the Golden Temple in Amritsar, the holiest shrine in Sikhism. The temple is home to the world’s largest langar (community kitchen) where anyone of any background can find a free meal or a place to sleep. Completely run by donations and volunteers who cook 24/7, the langar feeds 100,000 people every day, and tens of thousands more during religious festivals.

At a business and policy level, we saw this concept reflected in government digitisation initiatives like the Unified Payments Interface (UPI). When meeting with Paytm in Mumbai, one of India’s preeminent fintech companies that helped build the tech behind UPI and now offers innovative subscription-based payment solutions for vendors, we gained insight into the real-time digital payment system. Launched in 2016, UPI now accounts for 68 per cent of all payment transactions by volume. The UPI QR code is ubiquitous in India; operated by companies like Paytm, Phone Pe and Google Pay, it can be found in kirana stores (mom-and-pop shops), individual ice cream sellers parked in tourist areas, and even in chai stalls and fruit stands in the Dharavi slum, made famous by 2008 film Slumdog Millionaire. When buying tickets for a monument like the Taj Mahal or Humayun’s Tomb, you get a significant discount when paying with UPI or card, while cash-paying customers pay full price. (This is in line with Modi’s 2016 demonetisation campaign, which kickstarted India’s revolution in digital payments).

In an economy that is 50 per cent driven by consumption alone and where 90 per cent of that commerce happens at kirana stores, simplifying transactions and reducing payment transfer delays through UPI has a massive rippling effect. Improving cash flow for sellers and buyers alike encourages the establishment of new businesses and drives consumption. In 2021 alone, UPI unlocked USD12.6 billion in cost savings and USD14.6 billion of economic output in India. Beyond India’s megacities, UPI has started to find its footing in cash-dominant semi-rural and rural stores; in 2022, UPI transactions saw a 650 per cent increase in those regions. While urban areas rapidly digitise, India’s efforts to promote digital financial inclusion ensure the rural consumer doesn’t get left behind. 

After effectively digitising payments, India is now turning its attention to revolutionising e-commerce. In our meeting with Invest India in Delhi, the national investment promotion and facilitation agency, we got a glimpse into the Open Network for Digital Commerce (ONDC). This government initiative will make “digital commerce in goods and services available equitably to all Indian citizens,” according to ONDC’s Strategy Paper. Currently in testing and set to launch in mid-2023, ONDC will support a decentralized ecommerce network that all players – from Flipkart, Amazon, Uber and Zomato, to supermarkets, retailers and the 13 million kirana stores operating in India – can plug into. With all players in food, fashion, payment and travel accessible in one super-app, ONDC will enable any buyer to connect with any seller on the open network. The super-app will increase visibility of all merchants, including small and medium sellers that are often digitally excluded, expand choice and improve pricing for consumers, and drive healthy competition and a level playing field in an industry dominated by giants in other markets (think Amazon, Alibaba).

Having spent many years living and working in other emerging markets like Kazakhstan, Uzbekistan and Russia and following their efforts to improve market efficiencies and digitise, I find India’s journey incredibly compelling. India is conquering its unique conditions – which could easily impede another country’s journey – head on. Its mind-boggling density, ever-growing population, staggering ethnic and linguistic diversity, low smartphone/internet penetration, and limited infrastructure are the same conditions that are enabling India to leapfrog traditional consumption/development stages and go straight to digital, creating more efficient public and private services than we in the US could ever imagine.

India’s digital transformation has been commended by many, including the IMF in a recent working paper, as a world-class example for other countries to look to. Unlike many emerging markets where the private sector steps in to fill public service gaps, India’s government is a key innovator in the market and even a catalytic actor in the country’s digitisation journey. (When is the last time you heard a government described as a catalyst?). The goal behind Digital India is not merely to digitise specific public services, but rather build digital building blocks that can be used by both government and private players to “enable society-wide transformation” (IMF). India’s focus on building a digital environment that empowers, unites and supports innovation across the entire ecosystem is – to my mind – what sets it apart from the rest. 

In India, “there’s always room for one more,” and everything the country’s doing will ensure that this fast-rising tide indeed lifts all boats.

While crypto companies are left in limbo after the US Securities and Exchange Commission (SEC) Chair’s statement on most digital assets being securities, the world of investment funds suffers in its own way. Until a clear international regulatory framework is in force, funds remain in the dark at what level it is legal to interact with crypto assets.

Why digital assets’ classification is pressing to investment funds?

Crypto assets, also known as cryptocurrencies, are digital tokens that use cryptography to secure transactions and control the creation of new units. The regulatory classification of crypto assets as commodities or securities has been debated for several years.

An unambiguous classification can significantly impact the alternative investment funds (AIFs) and the fund industry overall. If classified as commodities, crypto assets may be subject to less regulatory oversight, making investing easier for funds. On the other hand, if classified as securities, they may be subject to stricter regulations, making it more challenging for funds to invest but offering investors more protection and transparency along the process.

A tradable financial asset (i.e. security) is subject to registration with regulatory authorities, disclosure and investor protection requirements, price transparency, and greater reporting demands in general. These regulations can increase accompanying costs and complexity for alternative investment funds dealing with digital assets.

Digital assets classified as commodities may be subject to fewer regulations, providing less investor protection, but lead to a new spectrum of controversies for investment funds. Due to particular investment strategies and policies, most funds do not trade commodities and work exclusively with securities. In this case, the classification directly affects whether the fund can invest in digital assets. 

Thus, alleviated regulations can, in theory, make AIFs’ operations with digital assets easier, but only if those funds are initially engaged with commodities. Due to the high market risk associated with the economic nature and the increased volatility of crypto assets, even significant fund investments can result in a dramatic price deterioration. 

The current debate around digital assets’ classification: the U.S. example

Some experts argue that crypto assets should be considered commodities, like gold or oil, since they are not backed by any government and have no intrinsic value. Others argue digital assets should be classified as securities as they are often used as investment instruments, and their value is subject to market fluctuations. 

The Commodity Futures Trading Commission (CFTC) and SEC have taken a case-by-case approach to classifying crypto assets. Both regulators agree that Bitcoin is a commodity, and CFTC extends this classification to Ethereum. In 2020, SEC filed an ongoing lawsuit against blockchain developer Ripple Labs, arguing that XRP, Ripple’s native token, is a security. Additionally, a Kraken case made some crypto CEOs believe that SEC is going after crypto staking for U.S.-based customers. If so, numerous leading crypto companies may start looking into other markets to settle in.

Along with the rest of the world, several proactive regulatory steps were made by the EU regulatory bodies aiming to integrate crypto assets in European financial markets.

Regulatory standpoint in the EU and implications for AIFs

As crypto assets become more mainstream, European regulators are increasingly scrutinising these investments to ensure they adhere to traditional investment standards.

The Fifth Anti-Money Laundering Directive (5AMLD), introduced in 2018, includes regulations of crypto asset service providers (CASPs) such as exchanges and wallets. According to the directive, CASPs must follow basic requirements to prevent money laundering: register with their local regulatory authority, conduct due diligence on their customers, and report any suspicious activity.

Moreover, the European Securities and Markets Authority (ESMA) qualifies crypto assets as financial instruments. Therefore, alternative investment funds operating in Europe may, in fact, invest in any traditional or alternative assets as long as the AIFM can ensure compliance with the AIFM Directive. In this way, investing in crypto assets, from the AIFM’s point of view, does not differ much from managing other types of assets, with no additional licence needed. 

Luxembourg’s regulator, The Commission de Surveillance du Secteur Financier (CSSF), in turn, states that an AIF may invest directly and indirectly in digital assets under the condition that its units are marketed only to professional and not retail investors. Investments in derivatives and transferable securities with underlying virtual assets are also considered as indirect investments in virtual assets. Additionally, each Luxembourg-authorised AIF investing in virtual assets needs to obtain prior authorisation from the CSSF for the strategy “Other-Other Fund-Virtual assets.”

Despite the regulatory challenges, the EU remains an attractive market for crypto asset funds due to its large and diverse investor base, solid financial infrastructure, and supportive startup ecosystem. To do so, the AIFM needs to be granted permission from the regulatory body for particular management strategies to invest in companies at their early stages.

Final words

The classification of crypto assets is not quite evident to grasp, as there has yet to be a clear regulatory consensus. While regulators worldwide struggle to come to a unified conclusion, investment funds engaged in the crypto industry find their operations complicated by the lack of clarity. 

Investment experts can expect heated debates regarding crypto assets’ classification and management in the following year. From the perspective of AIFMs, there is hope that recommendations of investment industry participants will be noted during the discussion and adoption of new regulations in the EU and worldwide.

Fans of Kevin Costner* may recall Field of Dreams. The above quote went to the heart of the 1989 film. It sprung to mind during our recent visit to India. Namely, that Indian infrastructure is finally shifting from a ‘hindrance’ to a ‘help’. In the words of The Economist, “India is getting an eye-wateringly big transport upgrade.”

Now those of you who know us as investors in Emerging Markets (“EM”) consumption may be asking how does this help Aubrey EM? Stay with us and the answer will become abundantly clear.

The current breakneck pace of infrastructure spend is most painfully obvious in Mumbai, where city planners are trying to build out 10 metro lines simultaneously, as well as a highly ambitious and partly submerged coastal expressway. It is the same story in Indore, India’s 17th most populous, and apparently cleanest, city where another metro line is under construction. This is more of a pre-emptive build, as we have become used to in China (‘if you build it…’).

However, most English-speaking journals reporting on this give the Modi administration little credit. The first dig is always that the development was set in motion by previous administrations. But we remember the great reforms of Narasimha Rao’s government in the early 1990s which were going to rid India of its ‘Hindu rate of growth’, and the numbers clearly suggest otherwise. In 1990, China and India had the same GDP per capita of around USD350 per head of population. Today, China’s number is 5x greater: USD12,500 vs USD2,500. There was precious little progress before Modi.

India’s previous investment boom was a decade ago, and was fuelled by public sector banks, whose balance sheets were compromised for a period of time. The resolution of these state banking problems was one of the thorniest issues facing the Modi administration but has finally been resolved through a combination of mergers and recapitalisation. India’s now well capitalised banking system is a key reason why a cyclical upturn is poised to reinforce the well-known structural story, with loan growth rising steadily for the first time in a decade.

There are multiple drivers for the coming investment upturn. However, the major one, in our view, will be private sector corporate capex. This will be from domestic corporates, most of whom (other than perhaps the Adani Group) are starting from a very strong and underleveraged financial position, as well as foreign companies.

At a little over USD80 billion last year, foreign direct investment (“FDI”) was at record levels for India, but in Chinese terms at least, it is still small. Modi’s reformed promotion body, ‘Invest India’, is helping, as are his production-linked incentive schemes. So too are state incentives as competition to land new investments intensifies. The poster boy is perhaps Apple, whose iPhone exports from India grew from USD100 million/month last April to a staggering USD1 billion/month in January this year. But manufacturing investment is broadening rapidly with flows from 162 countries, into 61 sectors and directed to 31 states and territories, that is, nearly all of them.

All the above helps to explain why India is now, not only a realistic destination for those seeking to diversify from China, but it is also becoming a more obvious one. None of this is to say FDI won’t continue to wash up on the shores of Vietnam, Indonesia, or Mexico, but an ever-increasing share is heading to India.

And this is where the potential for consumption comes in. India’s urbanisation rate is low, at around 35 per cent, and the opportunity is in growing this more rapidly. But why would you leave the farm if there are no jobs in the towns or cities to go to? What this investment upcycle implies is rising urban job creation, whether its construction, manufacturing, or associated service jobs, and only this will drive urbanisation. Experience tells us that an urban job comes with an income which is a multiple of the rural one left behind, and that multiplier drives consumption.

Our friendly Mumbai Uber driver, Sakir, was a case in point. Hailing from Chhattisgarh, one of India’s poorer states, he taught himself decent English which allowed him to negotiate the outrageous rate of INR2,500 (USD30) for a day driving around Mumbai. With his wife, who makes clothes, and two children he lives in a “small house”, for which read tenement. An apartment is not yet within reach but is an aspiration. As well as keeping them clothed, housed, and fed, he also pays for some form of private education for his children so that they can have a better future. No doubt, some funds also return to relatives back home. That USD30 USD, less the cost of running a half-respectable Maruti for the day, goes a long way.

*It’s reasonable to believe that following ‘Yellowstone’ his fan base will be larger now.