Financial Risk Assessment and Management in Times of Inflation

While deflation has been the focus of the recent global financial crisis, inflation has been a more pressing concern for policymakers. While Japan and the eurozone have worked to push up inflation, inflationary pressures have been building around the world. It is important to assess the inflation risk in your portfolio and make any necessary adjustments to your investment strategy. The following tips can help you understand inflationary risks and manage them in the short and long-term.

Long-Run Trajectory

One way to reduce risk tolerance assessment is to adjust spending. By reducing your spending, you can extend the life of your portfolio. The risk of inflation in the long run is real, but even a small cut can increase the odds that you won’t run out of money prematurely. Resetting spending levels after a storm can be a sound strategy, but investors should remember that the risk remains in place. This is because short-term shocks can deviate from the long-run trajectory.

Another way to manage inflation is to diversify your investment portfolio. By diversifying your portfolio across countries, you can take advantage of higher yielding financial instruments. You can also use a global marketplace to diversify your portfolio. BNP Paribas Securities Services, for example, offers true global currency coverage and is equipped to support cross-border diversification strategies. Through our extensive global network, we can anticipate and manage volatile credit risks.

Linked Strategies

In times of inflation, asset managers need to have a good understanding of inflation-linked strategies. With the current state of the global economy, inflationary effects are looming over the entire world. With a more uncertain world comes higher risk. It is important to select the right partners to help you manage the risk. If you are an investor, this means finding the right investment partner to help you achieve your long-term goals.

As a result, it is imperative for companies to reevaluate their pricing methodologies to take into account the higher inflationary costs. Companies need to develop pricing plans that will allow them to pass on these costs to customers. If they don’t want to raise their prices, they may consider price caps. Inflation is a risk that can affect any company’s financial statements. If you aren’t prepared to deal with the impact of inflation, consider consulting financial experts to help you manage this risk.

Economic Conditions

The current economic conditions must be understood and measured to make informed decisions about the right investments and portfolio allocation. With the recent increase in interest rates, this task has become even more crucial. Moreover, this task requires a holistic approach that takes into consideration the different sources of risk. To be successful in this endeavor, investors should adopt an inflation-hedging strategy and continually allocate their portfolio to assets that help them combat inflation.

Stock returns are inversely related to inflation. Inflationary pressures have the greatest impact on the Industrials sector, while those of Consumer Staples have the strongest inverse relation. As a result, it is essential to keep an eye on inflationary risks in the stock market. This risk is especially important if inflation is unpredictable. Moreover, unexpected changes in the US nominal interest rate can affect stock markets around the world.

Local Inflation Factor

Another key to managing inflationary risks is the Local Inflation factor. This factor attempts to capture the inflation expectations in the market by adjusting the total return difference between an inflation-linked bond index and the Treasury index. However, the local inflation factor may not be a perfect measure of market inflation expectations. Inflation breakevens fell sharply during the COVID-19-induced market crash. This likely was a result of falling expectations of inflation. Inflation expectations are increasingly considered as a critical consideration for investors in their investment strategies.

Final Thoughts:

The real rate of interest is negative. Inflation is positive in boom economies. Conversely, inflation can be negative in recessionary times. The real rate of interest is a good indicator of inflation, but the market’s expected rates of inflation are lower than actual ones. It is important to consider the inflation rate in your country when assessing risks in your portfolio. For example, if your country is experiencing a recession, your investment strategy may have a negative impact on inflation.