Will an Inflation Regime Continue to Drive Carbon?

| Multi Asset


Source: Unigestion, Bloomberg as of 17 November 2021.

Macroeconomic conditions are one of the key drivers of the carbon market. We examined the average performance of carbon across four macro regimes: recession, inflation surprise, market stress and steady growth. As can be seen from today’s chart, carbon performs best during inflation and growth regimes.

Indeed, strong economic growth dynamics imply a rise in demand for goods and services and the resulting manufacturing activity leads to higher emissions and thus a higher demand for emissions. The strong economic recovery post the Covid crisis is a significant factor behind the current rally in the price of carbon.

The risk of inflation surprise is the most supportive regime for carbon and the strong inflationary pressures in commodity and energy prices over the last year have led to an increase in the use of coal, pushing the green energy transition further away. The notorious by-product of burning coal is CO2, making it one of the most polluting sources of energy. Increased coal burning therefore automatically increases the demand for carbon. A potentially cold winter and the resulting demand for heating could act as a further catalyst for carbon.

Our proprietary Inflation Nowcasters and Newscasters are both pointing towards an elevated inflation surprise risk and show no signs of abating. It looks like the carbon rally therefore has further to run.

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