Weekly Market Update: US Inflation Unnerves Equity Markets
Mon 17 May 2021
Global economies are reopening, and moving into the recovery phase, this pickup in activity has lead investors to question the potential impact on inflation. Investors are cautious of whether inflationary effects will be transitory or long-lasting. The US inflation reading unnerved markets and all major equity markets fell last week. US equities fell -2.2% in Sterling terms, partly driven by currency effects, markets had sold off sharply at the start of the week before recovering in the latter half. UK equities, which typically move inversely to Sterling, due to high levels of overseas earnings, fell -1.2%. Japanese equities fared worst last week, caught in global equity volatility and increased lockdowns, falling -4.0% last week. Despite strong Chinese equity performance, emerging market equities fell -3.8% in Sterling terms. The US 10Y yield rose 5.1bps to 1.6%, while the UK 10Y rose 8.2bps to 0.9%. Both gold and oil were nearly unchanged, falling -0.2% and -0.1% on the week respectively.
Last week saw inflation figures in the US jump while retail sales numbers came in as a second big disappointment after weak jobs figures. Coupled with the usual fears about technology’s overvaluation, stocks corrected intra-week only to rise back up. Equity markets continue to defy a very good earnings season to focus on macroeconomic data. In a regime where risk asset prices have become so completely dependent on monetary policy, it is natural for investors to look for clues that would challenge that policy. However, despite the jump in inflation figures, one must be mindful of three things:
One: Macroeconomic data is and will continue to be volatile over the next few months. We often use year-on-year figures (e.g. April 2020 vs April 2021) to remove seasonal variation. But when comparing the worst economic year in modern history versus a period of sharp rebound, the image is distorted and the conclusions are limited. The traditional methods of gauging economic activity will be less useful until a modicum of economic normality is restored.
Two: Monthly inflation figures are influenced by both the re-openings and supply side issues. As the economy reopens, there’s pent-up demand. We saw this phenomenon exactly a year ago. With developed market demand picking up and supply chains unbalanced, as a large part of the emerging world, especially India, is experiencing an exacerbation in Covid-19 conditions, it is natural for short term inflation to pick up.
Three: The Federal Reserve is not worried. Market fears that the Fed will be influenced by these inflation figures imply a bet that the Fed along with other major central banks are wrong about the temporary nature of inflation and will be forced to hike rates. However, it is rare that markets, whose job is to focus on corporate profitability, are better judges of macroeconomic conditions than policy makers, whose job is exactly to peer into the minutiae of economic data releases.
Macroeconomic volatility will continue in the next few months, not just because of ‘counting’ issues but because the global economy is completely unbalanced. Markets look at macroeconomic figures to determine the stance of the Fed. This might be the wrong place to look, because the Fed itself is probably laser-focused on the implications of adding an extra $4tn to the real economy, on top of the $1.9tn already added, if Mr. Biden’s stimulus plan passes as is. The total amount added to the US economy in six months will almost equal the amount that the Fed added to markets in twelve years of quantitative easing. If the stimulus, directed at the real and not the financial economy, proves enough to break the ‘secular stagnation’ mindset, only then does long-term inflation become a possibility. But that inflation would be a consequence of real demand, real earnings growth and real investment and would bring asset pricing in a more normalised mode that markets haven’t seen probably since before the turn of the millennium.
To survive, liberal capitalism needs to work for more people. As the market’s ‘invisible hand’ hasn’t been particularly effective in addressing rising imbalances, the state needs to step in to restore some balance after a decade of stagnating incomes and political resentment. This may lead to a temporary re-rating of risk assets, but more market resilience over the long-term. The devil will be in the detail however. Over the next few months, market participants will have to become fiscal policy experts to determine whether the extra stimulus is aimed at activities that will release dormant economic powers, or whether it will just be a debt-widening exercise.
David Baker, CIO