US inflation is rising – but it’s not enough to rattle markets yet

Consumer prices in the US rose at an annual rate of 2.6% in March.

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published 14 April 2021

A beginner’s guide to inflation – everything you need to know Too embarrassed to ask: what’s the difference between producer price inflation and consumer price inflation?

US consumer price index inflation figures came out yesterday. Investors have been betting that reflation is on its way, and they are now looking for confirmation of that bet. So everyone was waiting for this latest reading with bated breath – and, as so often happens with the most-anticipated bits of data, it was all a bit of a damp squib. Consumer prices in the US rose at an annual rate of 2.6% in March. That was up from 1.7% in February, and a bit higher than the expected reading of 2.5%.

Now, obviously, this time last year inflation was diving because we were going into lockdown. So this reading suffers from “base effects”. In other words, we have an unusually low comparator month which means that this month was always going to look unusually high. However, as Will Denyer of Gavekal points out, even if you adjust for base effects, there is no doubt that “US inflation is trending up”.

There are two real questions at this point. One: how much inflation has the market already priced in? And two: how much more are we going to get? On the first point, the market was, to put it bluntly, underwhelmed by the figure. There were no fireworks. Bond yields didn’t push higher, and assets which have been struggling with higher interest rates (ie, rising bond yields) – including gold and the Nasdaq – did a bit better after the figure came out.

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In other words, the market reacted as though inflation had become less of an imminent threat than it had thought. The fact that the figure beat analysts’ expectations, yet didn’t inspire any big reaction in markets, makes it clear that investors were already heavily betting on a “surprise”. I realise that sounds a little bit contradictory. If markets are meant to price in the future, then why are they pricing in something different from the analysts’ consensus forecasts for the future?

The main thing to understand is that markets and analysts are two different things. There may be an analyst or economist consensus around an event, but if lots of investors already think that the data (or company report) will beat that consensus, then you won’t get much of a market reaction if it does. In other words, there’s a market consensus and an analyst consensus, and the two aren’t always the same. So markets were already positioned for a strong reading. The one they got was strong-ish, but not spectacularly so. Arguably, it was a bit of a damp squib as far as markets were concerned.

Meanwhile, we also got the news that the US medical regulator was putting a hold on the Johnson & Johnson vaccine for the moment. In practice, that doesn’t necessarily matter that much – the vast majority of vaccines in the US (where the rollout is going well) are Moderna or Pfizer. But clearly any stumbles on the road imply that it might take a bit longer to get to full activity again, which in turn is a negative for the reflation trade.

This is arguably the best possible outcome for the US Federal Reserve for now. It all points to a healthy recovery (so no major disappointment) but it also means investors will stop driving bond yields higher for the moment, which means the Fed can keep talking rather than acting. “Goldilocks” remains the core storyline. It also confirms that the “Great Rotation” trade is likely to continue taking a breather. We’ve already seen the Nasdaq hit fresh highs and we’re also seeing the Big Tech stocks finally get above the highs they last saw in August and September last year.

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John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.