“There’s no inflation…nothing to see here…oh…,” says James Knightley of ING. The US Federal Reserve has spent the last few months insisting that talk of impending inflation is overblown. That argument looks harder to sustain after US inflation surged to 4.2% on an annual basis in April, its highest reading since September 2008. Core prices (which exclude volatile food and energy costs) jumped 0.9% in a single month, their biggest monthly rise since 1981. Inflationary pressure will only intensify from here due to a “vibrant, strengthening” recovery in an economy that has “supply constraints”.
The inflation spike has rocked markets. Global stocks had their worst week since February, with the FTSE All-World index finishing last week down 1.5%. The selling continued into this week, with major US and European indices continuing to fall back on Monday. Gold, a traditional inflation hedge, hit a three-month high. Still, a bout of share-price weakness was “overdue” after such a lengthy rally, says Rupert Thompson of Kingswood. For now, the damage looks contained: the S&P 500 hit a new record high just a fortnight ago. A reopening economy had been expected to boost inflation, but not by this much. For markets, “the trillion-dollar question” is whether this is merely transitory, as the Fed insists, or “a sign of things to come”.
The Fed “prides itself” on following the data, says Will Denyer of Gavekal Research. So what about the data that shows US consumer inflation expectations for the year ahead have risen to 4.6%, or the fact that market expectations, as measured by the ten-year breakeven rate – the gap between yields on conventional bonds and inflation-protected bonds – are at “near decade highs”? Even professional forecasters, who are usually sceptical about inflationary talk, now see inflation averaging above the 2% target over the coming decade. The Fed’s ultra-loose monetary policy, which includes near-zero interest rates and $120bn of monthly asset purchases, is increasingly difficult to justify.
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Stockmarkets are on thin ice
America is a society where people “are used to getting what they want when they want it”, says The Economist. Yet supplies of everything from chicken breasts to microchips to lumber are running short (see page 5). Used-car prices soared an astounding 10% month-on-month in April. With fiscal and monetary support turbocharging the economy, investors should expect more “inflation scares”.
Central bankers are playing down the inflation threat, but they are hardly neutral observers, says Anthony Rowley in the South China Morning Post. Hiking interest rates would have disastrous consequences for the governments and corporations that have loaded up on debt since the pandemic began: to raise their borrowing costs now would “invite a global debt crisis of fearsome proportions”. Economists and investors had believed for decades that high inflation was a “thing of the past” no matter how low interest rates remained. That “dam of investor confidence” has “been breached”. A “severe market correction” is coming, it is just a question of when.
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