• Mark Beardow

Inflation shock or growth shock?

Concern about the rising risk of inflation has been pervasive over the last 6 months.

In this note we look into Australian inflation "shocks" and conclude that over the last 35 years there have been few episodes to try and gauge the reaction of bond and equity markets.

During the March quarter, Australian 10 year inflation expectations rose from 1.78% to 2.07%, Australian equities rose 4.26% and bonds fell by 3.52%.

The rise in expectations during the last 3 months is consistent with a reversion to prior averages and we think is better understood as a "positive growth shock" . The reaction of equity markets has been as expected but arguably bonds have overshot and performed worse than might be expected.

If inflation expectations stabilise then we expect bond markets will perform well in the current quarter.


We use quarterly data from the RBA and define an "inflation shock" when 10 year breakeven inflation rates rise materially (10% rise in rate). We have also overlaid this data with changes in short term inflation forecasts by professionals.

Over 35 years or 140 quarters, there have been just 25 instances ( 17% ) where 10 year breakeven inflation rates rose "materially" over a quarter. Focusing on data since 2000, there have been 15 "inflation shock" quarters. Remarkably 4 have occurred successively since peak panic in March 2020.

Australian equities (S&P ASX200) have performed very strongly in these 15 quarters with an average return of 4.98% while not surprisingly, the average quarterly bond return was -0.23% (S&P Fixed Interest Index). A 70:30 portfolio comprising equities and bonds, would have performed solidly during these "inflation shock" quarters.

Digging into the largest losses for bonds, the first quarter of 2021 was the largest loss (-3.52%) and the next largest was fourth quarter of 2016, (-3.16%) , post the Trump election and his stance on stimulus.

We then overlaid the shorter term inflation forecasts collected by the RBA and examined those quarters where both short term forecasts rose and and long term forecasts (materially) rose. This reduced the sample to just 6 quarters.

Equities again performed well while bonds underperformed (-1.39%), which was greater underperformance than in the previous scenario. A 70:30 portfolio comprising equities and bonds, would have performed solidly during these "inflation shock" quarters.

So while the recent sharp rise in inflation expectations since March 2020 has had few parallels over the last 30 years. We observe that this was from extremely depressed levels of (0.65% at March 2020 to 2.07% at March 2021) and we believe mostly reflects a positive growth shock.

Source: Darling Macro, S&P, Bloomberg. For wholesale investors only.