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Get set for an inflation scare

Investors are getting complacent about inflation. They should prepare themselves for a fright.

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The US labour market is tightening quickly

Credit: Richard Levine / Alamy Stock Photo

Strong US GDP figures carried a "sting in the tail", says The Economist. The world's largest economy shrugged off a government shutdown to expand at an annualised pace of 3.2% in the first quarter, comfortably outstripping consensus forecasts. Yet "quiescent" inflation running at an annual rate of 1.9% in March suggests that underlying demand could be weak, so the Federal Reserve is unlikely to resume hiking rates for now.

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The most likely path for US interest rates is now downwards, reckons Komal Sri-Kumar on Bloomberg. Central bankers are happy to take a dovish stance because previous predictions that ultra-low rates and quantitative easing (QE) would trigger surging inflation did not materialise. Between 2008 and 2015 the Fed's balance sheet of assets bought with printed money "more than quintupled", but inflation remained stubbornly below the 2% target. Other developed markets, including the UK and the eurozone, have had similar experiences.

Why hasn't it appeared yet?

This is especially the case since a crucial driver of inflation is now emerging, says Laurence Fletcher in the Financial Times: rising wages. Pay has been climbing for five years amid a tight labour market. It recently reached a ten-year high. This is a danger to the US-led global stockmarket rally on two counts. Higher costs mean lower corporate profit margins and earnings, which will undermine historically overvalued equities. The broader problem, however, is that investors are looking the other way.

An underrated risk

Any inflationary scare could prompt the US Federal Reserve, which has been counting on low inflation too, to raise interest rates fast to prevent price rises soaring out of control. That would remove a "key support" for global markets, as Fletcher says. It would also be very good news for gold.

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