Investors are ignoring the danger of inflation
US inflation is at its highest in almost 13 years, and UK CPI is rising at its fastest since August 2008. But stockmarkets have shrugged the figures off and bond investors are relaxed.
US inflation has hit the highest rate in almost 13 years. The consumer price index rose by 5% year-on-year in May, the fastest increase since August 2008. Core inflation, which strips out volatile food and energy costs, rose by an annual 3.8%, the measure’s biggest jump since June 1992. This week we also learnt that UK consumer prices rose at an annual pace of 2.1% last month, up from 1.5% in April.
Bonds investors are relaxed
Stockmarkets shrugged off the news, says Rupert Thompson of Kingswood. Global equities are now up by 13% so far this year. This is the second month in a row that US inflation has come in higher than forecast. You would expect bond yields, which move inversely to prices, to have risen (investors demand higher returns to compensate for higher inflation), yet they actually declined.
“What on earth is going on in the bond markets?”, asks Philip Aldrick in The Times. During the first quarter of the year, talk of inflation sent the US ten-year Treasury yield up from 0.95% up to 1.75%. Yet now it has slid back to 1.5% despite the inflation surge. Investors are being persuaded by the US Federal Reserve’s argument that the inflation spike is transitory.
Supporters of the Fed’s view point out that the inflation spike has been concentrated in a few stressed areas, says James Mackintosh in The Wall Street Journal. “Used cars and trucks alone accounted for a third of May’s monthly inflation”. Such reopening bottlenecks can be expected to ease as things get back to normal.
The Fed was proven right in 2011, when a similar spike did indeed turn out to be transitory. For all that, the fact that bond yields are falling is undeniably “bizarre”. Investors have put a lot of faith in the Fed, “leaving little room for it to be wrong”.
Post-financial crisis, quantitative easing (QE), or money printing, didn’t cause a spike because it was used to patch up the then-shaky financial system, says Liam Halligan in The Daily Telegraph. But this time support has been poured straight into the real economy, with money sent “directly into the bank accounts of households and firms via government furlough and business support schemes”. The Federal Reserve added $3trn of QE to its balance sheet last year; the Bank of England’s QE pile has more than doubled since the first lockdown. Oil prices are up by 80% over the past year. Global wholesale crop prices spiked by “an extraordinary 40% in May”, further evidence of inflation.
Statistical effects mean that US inflation may have peaked, says James Knightley for ING. But the Fed is wrong to say it will quickly return to the 2% target. Higher commodity prices, soaring consumer demand and labour shortages will keep prices buoyant. High prices in the US property market have also yet to feed through into rents. US inflation looks set to stay above 4% until early next year. Policymakers’ insistence that monetary policy can be left ultra-loose for years to come is looking increasingly silly. The Fed’s Jackson Hole conference, scheduled for August, “could be very interesting”.